Question 3

In November 2001, Wehav Funds, a profitable engineering firm, signed a loan guarantee as a third party for NoCertainty Company, a newly formed organization focused on pharmaceutical research and development. Because Wehav Funds was a reputed and successful company, the loan was processed and approved by the National Bank at the end of November 2001.

Due to the nature of the pharmaceutical industry, NoCertainty projects are considered inherently risky. The company is currently awaiting FDA approval of a miracle drug that, according to marketing research, has the potential to generate millions of dollars of revenue per year. If the drug is not approved, NoCertainty will not have the financial resources to continue business. The loan guarantee by Wehav Funds will come into effect and Wehav Funds has to front the full amount of the loan.

The end of the fiscal year is approaching, and as the auditors, you must decide how Wehav Funds must account for this loan guarantee in their financial statements.

Under what circumstances must you record a contingent liability on the balance sheet? When must if be disclosed in the notes?

What do you feel is the appropriate accounting treatment for the No Certainty transaction with Wehav Funds? Would your