Question

Northern Switching Ltd. (NSL) is a manufacturer of digital switching equipment and systems. The company has total assets of approximately $784 million. Each of the following events occurred after the end of NSL’s 20X8 fiscal year, but before the statements had been finalized:

a. NSL finalized an agreement to sell a major production facility to Cascade Cable Corporation for approximately $42 million cash. The sale includes buildings of approximately one million square feet, fixtures, equipment, and 63 acres of land. The property has an amortized cost of $28 million on NSL’s draft 20X8 SFP.

b. NSL reached agreement with an international banking corporation for credit support for up to $23 million of new sales to customers abroad.

c. The company has a U.S. subsidiary. NSL (i.e., the parent company) signed a repayment guarantee on a $50 million line of credit that Citibank issued to the subsidiary.

d. Marketable securities held by NSL at 20X8 year end, reported on the year end draft SFP at their market value of $14 million, were sold for $12 million.

e. The CEO of Crisco Corporation, NSL’s major competitor, accused a senior NSL executive of improperly accessing confidential information via an employee only portal on Crisco’s website and using that information for competitive advantage. Crisco said that the company will file a lawsuit to recover $76 million in damages. NSL vehemently denies the allegation.

 

Required:

Discuss what disclosure, if any, NSL should give to each of these events in its 20X8 financial statements.

Answer 1

a.   

The company has agreed to sell a probably significant portion of its production capacity. The cash inflow of $42 million certainly is a significant amount, and the gain of $14 million will most likely be significant in terms of 20X9 net income. This transaction should be disclosed in the notes as a subsequent event.

 

b.   

This credit facility seems to be in the normal course of operations. As the company seeks new customers and new markets, new financing arrangements will be sought for their customers. This does not need to be disclosed in the notes.

 

c.   

Guarantees require full disclosure. The nature and amount of the guarantee should be reported on NSL’s separate-entity financial statements. However, when NSL prepares consolidated financial statements, the obligation to Citibank is included as a liability and therefore need not be separately disclosed.

 

d.   

The securities are about 1.9% of NSL’s net assets x not a very significant amount. Nevertheless, NSL (and its auditors) should review the year-end 20X8 valuation of the securities to make certain that the valuation was fairly and ethically made and did not reflect any bias on the part of management to obtain the highest possible valuation. If the valuation was fair and unbiased, then the decline in value is due to market forces in 20X9 and has no effect on the year-end 20X8 financial statements.

 

e.   

This litigation should be reported as a subsequent event because it may have significant ramifications for the reputation and future operating viability of NSL. It is a piece of information that investors and creditors should have in order to assess the risks facing the company.