Question

Transit Airlines provides regional jet service in the Mid-South. The following is information on liabilities of Transit at December 31, 2016. Transit’s fiscal year ends on December 31. Its annual financial statements are issued in April.
1. Transit has outstanding 8.4% bonds with a face amount of $67 million. The bonds mature on July 31, 2025. Bondholders have the option of calling (demanding payment on) the bonds on July 31, 2017, at a redemption price of $67 million. Market conditions are such that the call option is not expected to be exercised.
2. A $45 million 8% bank loan is payable on October 31, 2022. The bank has the right to demand payment after any fiscal year-end in which Transit’s ratio of current assets to current liabilities falls below a contractual minimum of 1.9 to 1 and remains so for 6 months. That ratio was 1.75 on December 31, 2016, due primarily to an intentional temporary decline in parts inventories. Normal inventory levels will be reestablished during the sixth week of 2017.
3. Transit management intended to refinance $53 million of 4% notes that mature in May of 2017. In late February 2017, prior to the issuance of the 2016 financial statements, Transit negotiated a line of credit with a commercial bank for up to $48 million any time during 2017. Any borrowings will mature two years from the date of borrowing.
4. Transit is involved in a lawsuit resulting from a dispute with a food caterer. On February 13, 2017, judgment was rendered against Transit in the amount of $42 million plus interest, a total of $43 million. Transit plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company.

Required:
1. How should the 8.4% bonds be classified by Transit among liabilities in its balance sheet? (Enter your answer in millions.)
2. How should the 8% bank loan be classified by Transit among liabilities in its balance sheet? (Enter your answer in millions.)
3.How should the 4% notes be classified by Transit among liabilities in its balance sheet? (Enter your answers in millions.)
4. The lawsuit should be reported as:

a. A disclosure note only should be provided.
b. A loss should be accrued in the financial statements with an explanatory note.
c. No disclosure is necessary.
5.
Calculate the total current liabilities, total long-term liabilities, and total liabilities of a classified balance sheet for Transit Airlines at December 31, 2016. Transit's accounts payable and accruals were $55 million. (Enter your answers in millions.)

Answer 1

Answer and Explanation:

1. The 8.4% bonds should be classified as "current liability" in Transit's balance sheet. This is because there is an option of calling the bonds on July 31, 2017 and if the bond holders demand payment then the liability will have to be paid on July 31, 2017 and this will represent a period that is less than a year (from December 31, 2016 to July 31, 2017).

The amount to be recorded will be $67 million.

2. The 8% loan of $45 million will be recorded as a "long term liability". This is because the loan is payable in the year 2022 and so will be in the books for a period of more than one year. Also the decline in parts inventories is intentional and will be corrected. This will ensure that current ratio is in the required range.

The amount to be recorded is $45 million i.e. the amount of the loan.

3. The amount of $53 million - $48 million = $5 million will mature in May 2017. As the period is less than a year it will be recorded as a "current liability" and the amount will be $5 million.

The balance amount of $48 million will mature in two years from the date of borrowing. Hence the amount of $48 million will be recorded as a "long term liability".

4. For the lawsuit a disclosure note should be provided. This is because the suit is in appeal and as per accounting laws will not be considered probable.

5. Total current liabilities = accounts payable+8.4% bonds+current portion of 4% notes = $55 million+$67 million+$5 million = $127 million

Long term debt = 8% bank loan+4% notes = $45 million+$48 million = $93 million.

Total liabilities = current+long term = 127+93 = $220 million