Question

A supplier of electrical parts and motors company with annual sales of $14 million and employs a staff of 80. Company enters an agreement with Miles two days after the current September 30th year-end. Effective October 2, 2016, Mile’s services with the company were terminated due to his alleged inability to get along with his co-workers. In settlement of several counterclaims and legal threats by Miles over his termination, a financial agreement was reached. The agreement provides that the company will pay Miles or his beneficiary $30,000 annually for the next six years. The first payment will commence one year from the date of the agreement.

Question 1 ) Should generally accepted accounting principles do not require the recognition of liabilities for this agreement as of September 30, 2016, or as of September 30, liabilities of $180,000 for the agreement should be recognized ? What arguments in support of and against liability recognition ?

Question 2 ) What recommendation for agreement should be accounted for. Include in your discussion what year(s) the effects of the agreement (including specific dollar amounts) should be reported in the company’s balance sheet and income statement. Identify any accounts to be reported in the financial statements.

Answer 1

Contingent Liabilities shall be classified into three categories: High Probability, Medium Probability, and Remote Probability.

The first two, high and medium, shall be recognised in the financial statements in the notes to accounts. A contingent liability is recorded as liability when the liability becames certain and unavoidable.

In the given case, Agreement was entered into on 2 October, 2016, two days post the Year End Date. Important aspect to note over here is whether conditions existed during the year end September, 2016 for the liability to be recorded in the Financial Statement. It was only on 2 October, 2016 that Mile's services with the company were terminated due to his alleged inability to get along with his co-workers. In settlement of several counterclaims and legal threats by Miles over his termination, a financial agreement was reached to pay $30000 each year over the period of 6 years starting from October, 2016.

Hence, it it clear that conditions do not existed at the year end. So the company is liable to book any liability for the year ending September, 2016.

Answer 2.)

However, the Agreement shall be shown in the Notes to Accounts or Board's Report as liability to be provided for in the next accounitng year.