Question

Presented below are several facts related to ABC Company. Assume that no mention of these facts was made in the financial statements and the related notes. Your job is to determine the appropriate accounting treatment and disclosure to the notes to the financial statements. You must be specific on what details should be included to the notes of the financial statements.

1. It is probable the contingency will result in a $100,00 loss, but it is reasonably possible the loss could be $500,000.
2. Equipment purchases of $275,000 were partly financed during the year through the issuance of a $150,000 notes payable. The company offset the equipment against the notes payable and reported plant assets at $125,000.
3. ABC Company has reported its ending inventory at $2,500,000 in the financial statements. No other information related to inventories is presented in the financial statements and related notes.
4. ABC company changed its method of valuing inventories from weighted-average to FIFO. No mention of this change was made in the financial statements.

Answer 1

1. It is probable the contingency will result in a $100,00 loss, but it is reasonably possible the loss could be $500,000.

A contingent liability is recognized only when its occurrence can be estimated and it is probable. Thus, it is treated as below :

PARTICULARS	DEBIT	CREDIT
Loss	$ 100,000
To Contingent liability		$ 100,000

In notes to accounts, if the contingency loss is possible, then full disclosure is to be made regarding the possible contingency loss.

2. Equipment purchases of $275,000 were partly financed during the year through the issuance of a $150,000 notes payable. The company offset the equipment against the notes payable and reported plant assets at $125,000.

The proper accounting treatment in this case is to record the equipment in the asset side and the notes payable in the liability side of the Balance sheet. Here, offsetting of liability against the asset is made and thus, the gross amount must be mentioned in the notes to accounts.

3. ABC Company has reported its ending inventory at $2,500,000 in the financial statements. No other information related to inventories is presented in the financial statements and related notes.

As per the GAAP (Generally Accepted Accounting Principles), inventory is reported at lower of either cost or market value. Similarly, the method of determining the inventory cost (FIFO, LIFO, Average or weighted average method, specific identification method) should also be specified. Disclosures regarding the same, including how inventory valuation is done by the company, should be made in the notes to accounts.

4. ABC company changed its method of valuing inventories from weighted-average to FIFO. No mention of this change was made in the financial statements.

Changing the inventory valuation method involves change in accounting principles. Any change in the accounting principle requires restatement of the financial statements. The method used should be disclosed and the company may change its inventory valuation methods, provided it abides by the consistency principle of accounting in the subsequent years.