In an audit of the Marco Corporation as of December 31, 2011, the following situations exist. No entries have been made in the accounting records in relation to these items.
1. During the year 2011, the Marco Corporation was named as a defendant in a suit for damages by the Dalton Company for breach of contract. An adverse decision to the Marco Corporation was rendered and the Dalton Company was awarded $4,000,000 damages. At the time of the audit, the case was under appeal to a higher court.
2. On December 23, 2011, the Marco Corporation declared a common stock dividend of 1,000 shares with a par value of $1,000,000 of its common stock, payable February 2, 2012, to the common stockholders of record December 30, 2011.
3. The Marco Corporation has guaranteed the payment of interest on the 10-year, first mortgage bonds of the Newart Company, an affiliate. Outstanding bonds of the Newart Company amount to $5,500,000 with interest payable at 5% per annum, due June 1 and December 1 of each year. The bonds were issued by the Newart Company on December 1, 2009, and all interest payments have been met by that company with the exception of the payment due December 1, 2011. The Marco Corporation states that it will pay the defaulted interest to the bondholders on January 15, 2012.
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.*