Question

ATTENTION: I PAY EVERY MONTH TO BE ABLE TO POST QUESTIONS HERE. tHEREFORE I EXPECT COMPLETE AND QUALITY ANSWERS. PLEASE READ CAREFULLY THE QUESTIONS AND ANSWER THEM THOROUGHLY. DO NOT COPY AND PASTE A SOLUTION THAT IS ALREADY POSTED BY SOMEONE ELSE ON CHEGG. REFRAIN FROM ANSWERING IF YOU CANNOT FULFILL MY DEMAND. DON'T WASTE MY QUESTION AS THEY ARE LIMITED.

THANKS

Business Entities—Partnerships and Corporations

Assume Target Corporation is involved in a major lawsuit and the probable damages are estimated to be $2,000,000.

A. Describe the effects damage estimates would have on the financial statements of a corporation and a partnership.

B. How do disclosure requirements differ from a corporation to a partnership and what information is required?

C. Are the shareholders at risk for any personal liability with the company set up as a corporation? Defend your response.

D. If Target Corporation was set up as a partnership, would the partners be at risk for personal liability? Defend your response.

Answer 1

Target corporation is involved in a major lawsuit and the probable damages are estimated to be $2,000,000. This is in the nature of "Contingent liability". A contingent liability is a potential cost a company may or may not incur in the future. The probability of favourable or unfavourable outcome must be ascertained to decide the nature of reporting to be done in the financial statements.

A. Corporations are legally required to adhere to the accounting standards applicable to them, which are stricter in nature as compared to the partnerships, which are generally not legally required to follow those standards.

For corporations, based on the probability and the reliability of measurement of the amount (which in our case is clearly given), there are different disclosure requirements. As amount is already given, the possibility of unfavourable outcome can be- highly probable, possible or remotely possible.

For highly possible case, the amount should be debited to Profit & Loss statement as an expense and shown in Balance sheet as a liability. For possible case, the lawsuit and amount involved should be mentioned by way of notes to financial statement. For remote case, there is no need for any disclosure. But the corporation should be able to properly explain the basis for judging the possible outcome of the lawsuit.

For partnerships, in absence of any specific guidelines, they are free to choose whether to follow the accounting standards as applicable to corporations or not. Its a healthy practice to follow the accounting standards, but if they choose not to disclose the lawsuit in the financial statements in any manner until the lawsuit is decided, they must book the expense once the unfavourable ruling comes.

B. Disclosure requirements differ vastly for corporation and partnership as specific accounting standards are apllicable to corporations but not to partnerships.

For corporations, based on the probability and the reliability of measurement of the amount (which in our case is clearly given), there are different disclosure requirements. As amount is already given, the possibility of unfavourable outcome can be- highly probable, possible or remotely possible.

For highly possible case, the amount should be debited to Profit & Loss statement as an expense and shown in Balance sheet as a liability. For possible case, the lawsuit and amount involved should be mentioned by way of notes to financial statement. For remote case, there is no need for any disclosure. But the corporation should be able to properly explain the basis for judging the possible outcome of the lawsuit. Information which should be disclosed in notes to financial statements must include the nature of lawsuit, the amount involved and the management's estimate about the likely outcome of the lawsuit.

For partnerships, in absence of any specific guidelines, they are free to choose whether to follow the accounting standards as applicable to corporations or not. Its a healthy practice to follow the accounting standards, but if they choose not to disclose the lawsuit in the financial statements in any manner until the lawsuit is decided, they must book the expense once the unfavourable ruling comes. The information which should be disclosed is for patners to decide, but it should ideally include the nature of lawsuit, the amount involved and the partners' estimate about the likely outcome of the lawsuit.

C. As a corporation is a legal entity, which is limited by shares, the liability of the shareholders is limited to the amount paid or payable by them for the full value of shares, subscribed by them. Thus, in case a corporation is unable to discharge the amount payable in lawsuit, court can direct the shareholders to pay the amount oustanding against the shares subscribed by them, and if there is no outstanding, no further amounts are payable by shareholders. Hence, shareholders are NOT at risk of any further personal liability.

D. The nature of a partnership is such that it makes the partners 'jointly and severally liable' for the actions of the partnership firm. Hence they are personally liable for making good any sums payable by the partnership firm. In case the partnership firm is unable to pay the amount, the partners will be liable to pay from their personal property, to make good the amounts payable by the partnership firm. So, if Target corporation was set up as a partnership, the partners would be at risk for personal liability.