8-3

Harmon industries manufactures and sells industrial machinery around the world. The company is heavily dependent upon contracts with transatlantic and transpacific shipping companies to deliver its products. Because fuel prices are unpredictable, several of the shipping companies Harmon uses has included a clause in new contracts allowing them to impose a fuel supplement if the price of West TX intermediate fuel exceeds A stipulated price per barrel. Although the price of fuel is not expected to increase anytime soon, Harmons controller, Trent Johnson, is concerned about how he will account for the supplement if it is ever imposed. Typically, contracts state that the supplement may be imposed on June 30th each year to convert the shipping companies fuel purchases during the preceding 12 months. The amount of the surcharge levied on any one shipper, like Harmon, would be based on a formula that takes into account the number of shipments and tonnage shipped by that shipper during the period. Based on Harmons projections, such a levy could result in several millions of dollars of additional expenses.

Harmon has a fiscal year-end of December 31st. Mr. Johnson has asked you, a member of his accounting staff, to research the problem of accounting for any fuel supplement that may be imposed. He has asked you to look into these questions:

• should the supplement be treated as an expense of the period in which it is imposed, or should it be apportioned between the current and preceding periods in some manner?
• How should the supplement be reported (classified) in the financial statements?
• What type of risk disclosure (if any) should be included in financial statements?

Mr. Johnson has asked you to look into all accounting and reporting aspects of the situation and not just his list of questions period if he has left anything significant out of his list, you should cover that as well. Write a report to Mr. Johnsons responding to his concerns.

8-5

American Petroleum company (AP oil) owns and operates deep water drilling rigs in international waters off the coast of Euromania, a western European country. Several months ago, it experienced a disastrous explosion and fire at one of its rigs that resulted in a monumental oil spill, which has yet to be contained. The spill is expected to have dire effects on hundreds of miles of the Euromanian coastline, putting untold thousands of people in fishing, tourists, and supporting industries out of work since the disaster occurred in international waters the ability of the Euromanian courts to impose liability judgments against the AP is probably limited to its ability to seize whatever AP assets are located within its jurisdiction. These assets are carried on AP's books at 20 billion dollars. In addition, Euromanian law limits liability in such cases to a maximum of 107 million ($112 million). However due to a feeling of ethical obligation and in an effort to salvage the good name of the company AP's board of directors has agreed to honor all damage claims in an unlimited fashion it is estimated that the value of such claims could reach 93 billion ($97 billion).

Your firm has served as the auditors for AP for several years period AP's board of directors has requested that your firm prepare a report for the board discussing how its decisions should be reflected in AP's financial statements under US GAAP. Your supervisor Charles Brogan, has asked you to research the technical issues involved and prepare a briefing memo for him recommending how the issues should be handled; he will subsequently prepare the report for AP. He has told you not to be concerned with the issues of foreign currency translation, as that is well understood by AP. Prepare the memo for Mr. Brogan.