Question

Transit Airlines provides regional jet service in the Mid-South. The following is information on liabilities of Transit at December 31, 2018. Transit’s fiscal year ends on December 31. Its annual financial statements are issued in April.

Transit has outstanding 5.5% bonds with a face amount of $73 million. The bonds mature on July 31, 2027. Bondholders have the option of calling (demanding payment on) the bonds on July 31, 2019, at a redemption price of $73 million. Market conditions are such that the call option is not expected to be exercised.

A $22 million 7% bank loan is payable on October 31, 2024. The bank has the right to demand payment after any fiscal year-end in which Transit’s ratio of current assets to current liabilities falls below a contractual minimum of 1.9 to 1 and remains so for 6 months. That ratio was 1.75 on December 31, 2018, due primarily to an intentional temporary decline in parts inventories. Normal inventory levels will be reestablished during the sixth week of 2019.

Transit management intended to refinance $59 million of 5% notes that mature in May of 2019. In late February 2019, prior to the issuance of the 2018 financial statements, Transit negotiated a line of credit with a commercial bank for up to $53 million any time during 2019. Any borrowings will mature two years from the date of borrowing.

Transit is involved in a lawsuit resulting from a dispute with a food caterer. On February 13, 2019, judgment was rendered against Transit in the amount of $45 million plus interest, a total of $46 million. Transit plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company.

Required:
1. How should the 5.5% bonds be classified by Transit among liabilities in its balance sheet?
2. How should the 7% bank loan be classified by Transit among liabilities in its balance sheet?
3. How should the 5% notes be classified by Transit among liabilities in its balance sheet?
4. How should the lawsuit be reported by Transit?
5. Calculate the total current liabilities, total long-term liabilities, and total liabilities of a classified balance sheet for Transit Airlines at December 31, 2018. Transit's accounts payable and accruals were $51 million.

Answer 1

1. The 5.5% bonds are to be classified as long term liability as the maturity date is July 31, 2027. Even though the bondholders have the option of calling the bonds on July 31, 2019 , since the company expects the call option not to be exercised, the liability is a long - term liability.

2. The 7% bank loan is to classified as long term liability. this is because the ratio of current asets to current liabilities will be reestablished to the normal levels within six weeks in 2019 and the bank's right can only be exercised only if the ratio drops below 1.9 to 1 and stays for six months.

3. The 5% notes are to be classified as current liability , as the maturity date is May 2019. The fact that that the company has entered into a line of credit with a commercial bank for a two year loan does not matter in this case.

4. The liability arising from the lawsuit needs to be classified as a comtingent liability, as at December 31, 2018 the lawsuit was not decided.

5.  

(Millions)

Current Liabilities:

Accounts Payable $51

5% notes payable $59

Total Current Liabilities $110

Long-term liabilities:

5.5% Bonds $73

7% Bank loan $22

Total long-term liabilities $95

Total liabilities $205