The following information relates to the obligations of Villa Watch Co. as of December 31, 1997: . Accounts payable for goods and services purchased on open account amount to $35,000 at December 31, 1997. . On December 15, 1997, Villa declared a cash dividend of $.05 per common share, payable on January 12, 1998 to shareholders of record as of December 31, 1997. Villa had 1 million shares of common stock issued and outstanding throughout 1997. . On December 30, 1997, Villa entered a 6-year capital lease on a warehouse and made the first annual lease payment of $100,000. Villa's incremental borrowing rate was 12%, and the interest rate implicit in the lease, which was known to Villa, was 10%. The rounded present value factors for an annuity due for 6 years are 4.6 at 12% and 4.8 at 10%. . On July 1, 1997, Villa issued $500,000, 8% bonds for $440,000 to yield 10%. The bonds mature on June 30, 2003 and pay interest annually every June 30. At December 31, 1997, the bonds were trading on the open market at 86 to yield 12%. Villa uses the effective-interest method. Villa's 1997 pretax financial income was $850,000 and its taxable income was $600,000. The difference is due to $100,000 of permanent differences and $150,000 of temporary differences related to noncurrent assets. At December 31, 1997, Villa had cumulative taxable differences of $300,000 related to noncurrent assets. Villa's effective tax rate is 30%. Villa made no estimated tax payments during the year. Contingency information: Villa has been named a liable party for toxic waste cleanup on its land and must pay an as-yet undetermined amount for environmental remediation activities. An adjoining landowner, Clear Toothpaste Co., sold its property because of possible toxic contamination of the water supply and resulting potential adverse public reaction toward its product. Clear sued Villa for damages. There is a reasonable possibility that Clear will prevail and be awarded between $250,000 and $600,000 As a result of comprehensive risk assessment, Villa has discontinued rockslide insurance for its warehouse, which is located at the base of a mountain. The warehouse has never sustained rockslide damage, and the probability of sustaining future damage is only slight. Required: a. Prepare the liabilities section of Villa's December 31, 1997 balance sheet. b. Discuss the information Villa is required to disclose, either in the body of the financial statements or the notes thereto, related to bonds payable and capital leases included in the liabilities presented above. c. Explain how Villa should account for each contingency in its 1997 financial statements. Discuss the theoretical justification for each accounting treatment
