In an audit of the MidtownMidtown Corporation as of December 31, 20162016, the following situations exist. No entries have been made in the accounting records in relation to these items. During the year 20162016, the MidtownMidtown Corporation was named as a defendant in a suit for damages by the DogtownDogtown Company for breach of contract. An adverse decision to the MidtownMidtown Corporation was rendered and the DogtownDogtown Company was awarded $ 1 comma 500 comma 000$1,500,000 damages. At the time of the audit, the case was under appeal to a higher court. 2. On December 23, 20162016, the MidtownMidtown Corporation declared a common stock dividend of 9 comma 0009,000 shares with a par value of $ 6 comma 300 comma 000$6,300,000 of its common stock, payable February 2, 20172017, to the common stockholders of record December 30, 20162016. 3. The MidtownMidtown Corporation has guaranteed the payment of interest on the 10-year, first mortgage bonds of the NorthboroNorthboro Company, an affiliate. Outstanding bonds of the NorthboroNorthboro Company amount to $ 7 comma 000 comma 000$7,000,000 with interest payable at 10 %10% per annum, due June 1 and December 1 of each year. The bonds were issued by the NorthboroNorthboro Company on December 1, 20142014, and all interest payments have been met by that company with the exception of the payment due December 1, 20162016. The MidtownMidtown Corporation states that it will pay the defaulted interest to the bondholders on January 15, 20172017. Requirements a. Define contingent liability. b. Describe the audit procedures you would use to learn about each of the situations listed. c. Describe the nature of the adjusting entries or disclosure, if any, you would make for each of these situations. (AICPA adapted.) Requirement a. Define contingent liability. A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place. a potential legal claim against a client where the condition for a claim exists but no claim has been filed. an agreement that the entity will hold to a fixed set of conditions, regardless of what happens to profits or to the economy. an event that occurred after the balance sheet date that affects the fair presentation or disclosure of the statements being audited. Requirement b. Describe the audit procedures you would use to learn about each of the situations listed. Begin by identifying all of the audit procedures you would use to learn about situation 1. (Select the 4 choices that apply.) A. Analyze legal expense for the period under audit and review invoices and statements of legal counsel for indications of contingent liabilities. B. Confirm details of stock transactions with registrar and transfer agent. C. Discuss the existence and nature of possible contingent liabilities with management and obtain appropriate written representations. D. Review current and previous years' internal revenue agent reports for income tax settlements. E. Review financial statements of affiliate, and where related party transactions are apparent, make direct inquiries of affiliate management, and perhaps even examine records of affiliate if necessary. F. Review the minutes of directors' and stockholders' meetings for indication of lawsuits or other contingencies. G. Review records for unusual journal entries made to the equity accounts (Common stock and Retained earnings) subsequent to year-end. H. Obtain letters from all major attorneys performing legal services for the client as to the status of pending litigation or other contingent liabilities. I. Discuss, specifically, any related party transactions with management and include information in letter of representation. Identify all of the audit procedures you would use to learn about situation 2. (Select the 6 choices that apply.) A. Confirm details of stock transactions with registrar and transfer agent. B. Review the minutes of directors' and stockholders' meetings for indication of lawsuits or other contingencies. C. Discuss, specifically, any related party transactions with management and include information in letter of representation. D. Review financial statements of affiliate, and where related party transactions are apparent, make direct inquiries of affiliate management, and perhaps even examine records of affiliate if necessary. E. Review current and previous years' internal revenue agent reports for income tax settlements. F. Obtain letters from all major attorneys performing legal services for the client as to the status of pending litigation or other contingent liabilities. G. Review records for unusual journal entries made to the equity accounts (Common stock and Retained earnings) subsequent to year-end. H. Analyze legal expense for the period under audit and review invoices and statements of legal counsel for indications of contingent liabilities. I. Discuss the existence and nature of possible contingent liabilities with management and obtain appropriate written representations. Identify all of the audit procedures you would use to learn about situation 3. (Select 6 choices that apply.) A. Review the minutes of directors' and stockholders' meetings for indication of lawsuits or other contingencies. B. Confirm details of stock transactions with registrar and transfer agent. C. Analyze legal expense for the period under audit and review invoices and statements of legal counsel for indications of contingent liabilities. D. Review records for unusual journal entries made to the equity accounts (Common stock and Retained earnings) subsequent to year-end. E. Obtain letters from all major attorneys performing legal services for the client as to the status of pending litigation or other contingent liabilities. F. Review financial statements of affiliate, and where related party transactions are apparent, make direct inquiries of affiliate management, and perhaps even examine records of affiliate if necessary. G. Review current and previous years' internal revenue agent reports for income tax settlements. H. Discuss, specifically, any related party transactions with management and include information in the letter of representation. I. Discuss the existence and nature of possible contingent liabilities with management and obtain appropriate written representations. Requirement c. Describe the nature of the adjusting entries or disclosure, if any, you would make for each of these situations. Begin by selecting the appropriate nature of the adjusting entries or disclosure, if any, needed for each situation. (Assume that in situation 1, the likelihood of MidtownMidtown having to pay the $ 1 comma 500 comma 000$1,500,000 damages is reasonably possible. For situation 3, assume that likelihood that MidtownMidtown Corporation will need to pay the December 1, 20162016 defaulted interest is probable.) Situation Financial Statement Treatment 1 2 3 Now record any adjusting entry required by each situation as of December 31, 20162016. (Record debits first, then credits. Exclude explanations from any journal entries. Select "No entry required" on the first line of the Accounts column if an adjusting entry is not needed and leave all other cells blank.) Begin by recording any adjusting entry required by situation 1. Journal Entry Date Accounts Debit Credit Dec 31 Next, record any year-end adjusting entry required by situation 2. Journal Entry Date Accounts Debit Credit Dec 31 Now record any year-end adjusting entry required by situation 3. Journal Entry Date Accounts Debit Credit Dec 31