Question

During Year 3, Manfred Corp. guaranteed a supplier’s $500,000 loan from a bank. On October 1, Year 4, Manfred was notified that the supplier had defaulted on the loan and filed for bankruptcy protection. Counsel believes Manfred will probably have to pay between $250,000 and $450,000 under its guarantee. As a result of the supplier’s bankruptcy, Manfred entered into a contract in December Year 4 to retool its machines so that Manfred could accept parts from other suppliers. Retooling costs are estimated to be $300,000. What amount should Manfred report as a liability in its December 31, Year 4, balance sheet?

Answer 1

Explanation:

When two conditions are met, a potential loss is accrued: an benefit is either disproportionate or debt is sustained on a balance sheet date and the magnitude of a loss is reasonably estimatable.  

When the calculation is below a given range and there appears to be no better estimation than any other beyond that range, the minimum limit will be applied.

Therefore, it is appropriate to include as liabilities the total sums ($250,000) of the probable promised payout. Once the device is purchased, the retrofitting expenses should be paid, as they greatly boost future computer operation.