17–4bEnforceability of Limitation-of-Liability Clauses

Learning Objective 5

What is a limitation-of-liability clause, and when will courts enforce it?

Whether a limitation-of-liability clause in a contract will be enforced depends on the type of breach that is excused by the provision. Clauses that normally will not be enforced include provisions excluding liability for fraudulent or intentional injury or for illegal acts or other violations of law. Clauses excluding liability for negligence may be enforced in certain situations, however. When an exculpatory clause for negligence is contained in a contract made between parties who have roughly equal bargaining positions, the clause usually will be enforced.

Case Example 17.14

Engineering Consulting Services, Ltd. (ECS), contracted with RSN Properties, Inc., a real estate developer, to perform soil studies for $2,200 and render an opinion on the use of septic systems in a residential subdivision being developed. A clause in the contract limited ECS’s liability to RSN to the value of the engineering services or the sum of $50,000, whichever was greater.

ECS concluded that most of the lots were suitable for septic systems, so RSN proceeded with development. RSN constructed roads and water lines to the subdivision in reliance on ECS’s conclusions, which turned out to be incorrect. RSN sued ECS for breach of contract and argued that the limitation-of-liability clause was against public policy and unenforceable. The court, however, enforced the limitation-of-liability clause as “a reasonable allocation of risks in an arm’s-length business transaction.”

Reviewing … Breach and Remedies

Kyle Bruno enters into a contract with X Entertainment to be a stuntman in a movie. Bruno is widely known as the best motorcycle stuntman in the business, and the movie Xtreme Riders has numerous scenes involving high-speed freestyle street-bike stunts. Filming is set to begin August 1 and end by December 1 so that the film can be released the following summer. Both parties to the contract have stipulated that the filming must end on time in order to capture the profits from the summer movie market.

The contract states that Bruno will be paid 10 percent of the net proceeds from the movie for his stunts. The contract also includes a liquidated damages provision, which specifies that if Bruno breaches the contract, he will owe X Entertainment $1 million. In addition, the contract includes a limitation-of-liability clause stating that if Bruno is injured during filming, X Entertainment’s liability is limited to nominal damages. Using the information presented in the chapter, answer the following questions.

One day, while Bruno is preparing for a difficult stunt, he gets into an argument with the director and refuses to perform any stunts. Can X Entertainment seek specific performance of the contract? Why or why not?

Suppose that while performing a high-speed wheelie on a motorcycle, Bruno is injured by an intentionally reckless act of an X Entertainment employee. Will a court be likely to enforce the limitation-of-liability clause? Why or why not?

What factors would a court consider to determine if the $1 million liquidated damages clause is valid or is a penalty?

Suppose that there was no liquidated damages clause (or the court refused to enforce it) and X Entertainment breached the contract. The breach caused the release of the film to be delayed by many months. Could Bruno seek consequential (special) damages for lost profits from the summer movie market in that situation? Explain.

Debate This

Courts should always uphold limitation-of-liability clauses, whether or not the two parties to the contract had equal bargaining power.

Need help with this Discussion #4 below.

See the 17-4, Limitation-of-Liability Clauses and at the end of Chapter 17, Reviewing...Breach and Remedies

Answer by incorporating facts, laws, rules, factors, etc., into your argument.

Debate this/Arguments/Discussion: Courts should always uphold limitation-of-liability clauses, whether or not the two parties to the contract had equal bargaining power.

Thunder Bay Entertainment Inc. has two separate divisions: DVD rental and sporting goods. The beta of the entire company is 1.25. The beta of the DVD rentals division is 0.8 and the beta of the sporting goods division is 1.5. The risk-free rate is 4 percent and the market risk premium is 7.5 percent. Which of the following independent projects should the company undertake?

2. Blockbuster Entertainment manufactures digital video equipment. For each unit $500 of direct material is used and there is $1,500 of direct manufacturing labour at $30 per hour. Manufacturing overhead is applied at $35 per direct manufacturing labour hour. Calculate the cost of each unit.
a. $4,975
b. $4,025
c. $3,750
d. $4,150
e. $4,725

3. In an activity-cost pool
a. a measure of the activity performed serves as the cost allocation base.
b. the costs have a cause-and-effect relationship with the cost-allocation base for that activity.
c. the cost pools are homogeneous over time.
d. costs in a cost pool can always be traced directly to products.
e. each pool pertains to a narrow and focused set of costs.

Answer the following question(s) using the information below.
Peter’s Printers has contracts to complete weekly supplements required by forty-six customers. For the year 2019, manufacturing overhead cost estimates total $360,000 for an annual production capacity of 7.2 million pages.


For 2019, Peter’s Printers has decided to evaluate the use of additional cost pools. After analyzing manufacturing overhead costs, it was determined that number of design changes, setups, and inspections are the primary manufacturing overhead cost drivers. The following information was gathered during the analysis:
Cost pool Manufacturing overhead costs Activity level
Design changes $60,000 400 design changes
Setups 260,000 5,000 setups
Inspections 40,000 10,000 inspections
   Total manufacturing overhead costs $360,000
During 2019, two customers, World Makers and Happy Studios, are expected to use the following printing services:

Activity World Makers Happy Studios
Pages 60,000 76,000
Design changes 10 0
Setups 20 10
Inspections 30 38

4. What is the cost driver rate if manufacturing overhead costs are considered one large cost pool and are assigned based on 7.2 million pages of production capacity?
a. $0.05 per page
b. $0.035 per page
c. $0.35 per page
d. $0.025 per page
e. $0.045 per page

5. Using pages printed as the only overhead cost driver, what is the manufacturing overhead cost estimate for World Makers during 2019?
a. $2,500
b. $21,000
c. $3,000
d. $2,700
e. $2,100


6. Assuming activity-cost pools are used, what are the activity-cost driver rates for design changes, setups, and inspections cost pools?
a. $200 per change, $64 per setup, $5 per inspection
b. $150 per change, $52 per setup, $5 per inspection
c. $150 per change, $64 per setup, $5 per inspection
d. $150 per change, $52 per setup, $4 per inspection
e. $200 per change, $5 per setup, $64 per inspection
Short Answer
The following costs are attributed to the Quilt Company:
Purchase of raw materials (all direct) $297,100
Direct labour cost $141,800
Manufacturing overhead costs $175,160
Inventories:
Beginning raw materials $10,000
Ending raw materials $900
Beginning work in process $20,000
Ending work in process $10,800
Beginning finished goods $20,000
Ending finished goods $5,800

Quilt Company used a 120% predetermined overhead rate based on direct labour cost.
Required:
7. Calculate the cost of goods manufactured.
8. What was the cost of goods sold before adjusting for any under or over applied overhead?
9. By how much was manufacturing overhead cost under or over applied?
10. Would the summary journal entry to close any under or over applied manufacturing overhead cost be a debit or credit to COGS?

2. Blockbuster Entertainment manufactures digital video equipment. For each unit $500 of direct material is used and there is $1,500 of direct manufacturing labour at $30 per hour. Manufacturing overhead is applied at $35 per direct manufacturing labour hour. Calculate the cost of each unit.
a. $4,975
b. $4,025
c. $3,750
d. $4,150
e. $4,725

3. In an activity-cost pool
a. a measure of the activity performed serves as the cost allocation base.
b. the costs have a cause-and-effect relationship with the cost-allocation base for that activity.
c. the cost pools are homogeneous over time.
d. costs in a cost pool can always be traced directly to products.
e. each pool pertains to a narrow and focused set of costs.

Coney Island Entertainment issues $1,600,000 of 6% bonds, due in 15 years, with interest payable semiannually on June 30 and December 31 each year. Calculate the issue price of a bond and complete the first three rows of an amortization schedule when:

2. The market interest rate is 7% and the bonds issue at a discount. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round interest rate factors.)

3. The market interest rate is 5% and the bonds issue at a premium. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round interest rate factors.)

You are a prominent lawyer representing entertainment industry individuals and high visibility professional athletes. Your client, Green Bay Packers quarterback Aaron Rodgers, wishes to buy Professor Conrad’s vintage Jaguar sedan which Conrad is anxious to sell to pay off gambling debts. Rodgers, hearing rumors of Conrad’s questionable character, retains you to ensure that the contract he’s about to enter into is a legal one.

Contract for the Sale of Used Car

This is a contract made between the Seller, Mark R. Conrad, and the Buyer,

Aaron Rodgers, for the sale of Seller’s vintage 1980 Jaguar four-door sedan in electric silver with sunset red leather interior.

The VIN number is 007-1950-BRLN-JLO-1971, and the odometer reads 173,000 km.
as of July 11, 2018.

The date of sale is July 14, 2018. Buyer agrees to pay to Seller the purchase price of $8,975 to be paid by a certified check issued by Wells Fargo Bank N.A., Minneapolis MN.

The car is sold “AS IS.” Seller makes no warranties about the condition of the car.

Seller will provide the Buyer with the vehicle’s title and the past twelve months service records.

Prepare a memo for client Rodgers identifying what elements are required to have a legal contract, e.g., “An offer”. For each element write a brief statement if it appears that element is present under the circumstances described along with the draft contract below.

Rodgers just needs the facts, so keep the memorandum brief. Along with commenting on each element, give Mr. Rodgers your final advice…sign/do not sign.

Technology Co. manufactures DVDs for computer software and entertainment companies.

TrueTrue

uses job order costing. On

NovemberNovember

​2,

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began production of

5 comma 7005,700

​DVDs, Job​ 423, for

DioramaDiorama

Pictures for

$ 1.40$1.40

sales price per DVD.

TrueTrue

promised to deliver the DVDs to

DioramaDiorama

Pictures by

NovemberNovember

5.

TrueTrue

incurred the following direct​ costs:

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​(Click the icon to view the​ costs.)                                                                        

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​(Click the icon to view additional​ information.)Read the requirements

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.

Requirement 1. Prepare a job cost record for Job 423. Calculate the predetermined overhead allocation rate​ (round to two decimal​ places); then allocate manufacturing overhead to the job.

Begin by determining the total amount of direct materials and direct labor incurred on the job.​ Next, calculate the predetermined overhead allocation rate and apply manufacturing overhead to the job.​ Lastly, compute the total cost of Job 423 and the cost per DVD.

Requirement 2. Journalize in summary form the requisition of direct materials and the assignment of direct labor and the allocation of manufacturing overhead to Job 423. Wages are not yet paid. ​(Record debits​ first, then credits. Exclude explanations from any journal​ entries.)

Start by journalizing the use of direct materials.

​Next, journalize the use of direct labor.

Now journalize the allocation of overhead to Job 423.

Requirement 3. Journalize completion of the job and the sale of the

5 comma 7005,700

DVDs on account. ​(Record debits​ first, then credits. Exclude explanations from any journal​ entries.)

Begin by preparing the entry to show the completion of the job.

​Next, journalize the revenue portion of the sale of Job 423.

​Finally, journalize the cost of goods portion of the sale.

Data Table

1. Shiloh’s Entertainment has the following Shareholders’ Equity as of January 1, 2018:

Preferred Shares, 8% cumulative, 10,000 issued, 50,000 authorized                          $ 500,000

Common Shares, 250,000 issued, unlimited authorized                                                   1,000,000

Contribution Surplus – Common Shares                                                                                      45,000

Retained Earnings                                                                                                                            2,500,000

Accumulated Other Comprehensive Income                                                                           150,000

During the year the following transactions occurred:

• A buyback of 5,000 common shares at a market value of $50 per share;
• A 10% common stock dividend was declared and paid at a market value of $49 per share;
• A 2:1 common share stock split was declared and paid, after the split the market valve of a share was $25;
• Issued 5,000 common shares at a market value of $27 per share and there was a $5,000 legal fee associated with the issuance;
• Bought a piece of specialized equipment with a fair value of by issuing 5,000 common shares at a market price of $26 per share.

Required: Based on the above information

1. Prepare ALL the journal entries for the year pertaining to Shiloh’s Shareholders’ Equity;
2. Complete the Shiloh’s 2018 Changes to Shareholders’ Equity (denoting number of shares outstanding for both Preferred and Common Shares).

Acquisition Cost, Equity Method, Eliminating Entries, Second Year

Peak Entertainment acquires all of the stock of Saddlestone Inc. on January 1, 2020. In preparing to consolidate the trial balances of Peak and Saddlestone at December 31, 2021 (two years after the acquisition), you assemble the following information:

Date-of-acquisition information:

• Value of stock given up to acquire Saddlestone: $20,000,000.

• Direct merger costs: $250,000.

• Saddlestone’s shareholders’ equity: $7,200,000, consisting of capital stock, $2,000,000; retained earnings, $5,000,000; accumulated other comprehensive income, $200,000.

• Fair value of earnings contingency agreement to be paid in cash: $300,000.

• Fair value of previously unrecorded identifiable intangibles (5-year life): $2,000,000. There are no revaluations of Saddlestone’s reported net assets.

Information for 2020 and 2021:

• Saddlestone’s reported net income for 2020: $3,000,000; for 2021: $3,500,000.

• Saddlestone’s reported other comprehensive income for 2020: $100,000 net income; for 2021: $25,000 net loss.

• Saddlestone declared and paid dividends of $1,000,000 each year.

• Goodwill and identifiable intangibles are not impaired in 2020; goodwill is impaired by $200,000 in 2021.

Required

a. Prepare the 2020 and 2021 journal entries made by Peak to record its investment, using the complete equity method.

Enter numerical answers using all zeros (do not abbreviate in thousands or in millions).

b. Prepare the consolidation eliminating entries made at December 31, 2021.

Enter numerical answers using all zeros (do not abbreviate in thousands or in millions).

Coney Island Entertainment issues $1,500,000 of 5% bonds, due in 10 years, with interest payable semiannually on June 30 and December 31 each year.

Calculate the issue price of a bond and complete the first three rows of an amortization schedule when:

Required:
1. The market interest rate is 5% and the bonds issue at face amount. (FV of $1, PV of $1, FVA of $1, and PVA of $1) (Use appropriate factor(s) from the tables provided. Do not round interest rate factors. Round your answers to nearest whole dollar.)