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E13-13 (Contingencies) Presented below are three independent situations. Answer the question at the end of each situation.

1. During 2012, Maverick Inc. became involved in a tax dispute with the IRS. Maverick’s attorneys have indicated that they believe it is probable that Maverick will lose this dispute. They also believe that
Maverick will have to pay the IRS between 800,000 and 1,400,00 After the 2012 financial statements
were issued, the case was settled with the IRS for 1,200,000 What amount, if any, should be
reported as a liability for this contingency as of December 31, 2012?

2. On October 1, 2012, Holmgren Chemical was identified as a potentially responsible party by the Environmental Protection Agency. Holmgren’s management along with its counsel have concluded that it is probable that Holmgren will be responsible for damages, and a reasonable estimate of these damages $6,000,000 . Holmgren’s insurance policy of 9,000,000 has a deductible clause of 500,000
How should Holmgren Chemical report this information in its financial statements at December 31, 2012?

3. Shinobi Inc. had a manufacturing plant in Darfur, which was destroyed in the civil war. It is not certain who will compensate Shinobi for this destruction, but Shinobi has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant but more than its book value. How should the contingency be reported in the financial statements of Shinobi Inc.?

P13-9 Sycamore Candy Company offers a CD single as a premium for every 5 candy bar wrappers presented by customers together with $2.50. The candy bars are sold by the company to distributors for $0.30 cents each. The purchase price of each CD to the company is $2.25 in addition, it costs $0.50 cents to mail each CD. The results of the premium plan for the years 2012 and 2013 are as follows. (All purchases and sales are for cash.)

 2,012 2,013
CDs purchased 250,000330,000
Candy bars sold 2,895,4002,743,600
Wrappers redeemed 1,200,0001,500,000
2012 wrappers expected to be redeemed in 2013 290,000
2013 wrappers expected to be redeemed in 2014 350,000

(a) Prepare the journal entries that should be made in 2012 and 2013 to record the transactions related to
the premium plan of the Sycamore Candy Company.
(b) Indicate the account names, amounts, and classifications of the items related to the premium plan that would appear on the balance sheet and the income statement at the end of 2012 and 2013.

*E14-21 (Term Modification without Gain—Debtor’s Entries) On December 31, 2010, the American Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,000,000 note receivable by the following modifications:

1. Reducing the principal obligation from $3,000,000 to $2,400,000.
2. Extending the maturity date from December 31, 2010, to January 1, 2014.
3. Reducing the interest rate from 12% to 10%.
Barkley pays interest at the end of each year. On January 1, 2014, Barkley Company pays $2,400,000 in cash to Firstar Bank.

(a) Will the gain recorded by Barkley be equal to the loss recorded by American Bank under the debt
(b) Can Barkley Company record a gain under the term modification mentioned above? Explain.
(c) Assuming that the interest rate Barkley should use to compute interest expense in future periods
is 1.4276%, prepare the interest payment schedule of the note for Barkley Company after the debt
(d) Prepare the interest payment entry for Barkley Company on December 31, 2012.
(e) What entry should Barkley make on January 1, 2014?

E21-7 (Lessee-Lessor Entries, Sales-Type Lease) On January 1, 2012, Palmer Company leased equipment to Woods Corporation. The following information pertains to this lease.

1. The term of the noncancelable lease is 6 years, with no renewal option. The
equipment reverts to the lessor at the termination of the lease.
2. Equal rental payments are due on January 1 of each year, beginning in 2012.
3. The fair value of the equipment on January 1, 2012, is 200,000 and its cost is $150,000
4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,000
Woods depreciates all of its equipment on a straight-line basis.
5. Palmer sets the annual rental to ensure an 11% rate of return. Woods’s incremental borrowing rate is
12% , and the implicit rate of the lessor is unknown.
6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround
the amount of costs yet to be incurred by the lessor.

(Both the lessor and the lessee’s accounting period ends on December 31.)
(a) Calculate the amount of the annual rental payment.
(b) Prepare all the necessary journal entries for Woods for 2012.
(c) Prepare all the necessary journal entries for Palmer for 2012.

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