302726 2111.04

Question 1

Liability

Answer 1

Liability is the state of being legally responsible for making good, making right, or making whole the wronged or owed party. Liability may include payment for debts, reimbursement for losses or damage, or payment of penalties.

Question 2

Unconditional

Answer 2

“Unconditional” is said of the promise or order on commercial paper. It is not subject to, or limited by, any modifying circumstance or prerequisite. A promise or order is conditional if the instrument states that it is “subject to” or “governed by” another agreement or is to be paid “only” out of a particular fund or source (for a nongovernmental unit).

An order or promise is not conditional although the instrument:

• states its consideration.
• refers to the transaction out of which it arose.
• states that it is secured by a mortgage or other security device.
• indicates a particular account, fund, or source from which payment may be drawn.
• states that it is to be paid “only” out of a particular fund or source (for a governmental unit).
• is payable only out of the entire assets of a partnership, trust, estate, or unincorporated association.
• states that it is drawn under a letter of credit.
  UCC 3-106

Question 3

2111.04

Answer 3

A general principle of accounting is that the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists. For example, a debtor with a payable to an entity may not offset a receivable from that same entity and display only the difference as a net payable or receivable unless the following specified conditions are met for the right of setoff to exist:

a. Each of the two parties owes the other determinable amounts.
b. The reporting party has the right to set off the amount owed with the amount owed by the other party.
c. The reporting entity intends to set off.
d. The right of setoff is enforceable at law.

Question 4

A company issued a financial instrument that unconditionally requires the company to settle the obligation by issuing common stock with a value of $500,000 on the settlement date. How should the company report this instrument in its financial statements?

As a liability in the balance sheet

As an equity instrument in the balance sheet

By only disclosing a liability in the notes

By only disclosing an equity instrument in the notes

Answer 4

As a liability in the balance sheet

An unconditional promise to pay a debt at a fixed point in time matches the definition of a liability. The company owes for a benefit and must pay. The method of payment is not relevant to the existence of the liability.

Note disclosure would be insufficient for a liability with a known dollar value ($500,000) but may be necessary in addition to the balance sheet recognition. An equity instrument would be an asset, not a liability.