A major defense contractor, LTV, faced with huge liabilities, once declared Chapter 11 bankruptcy protection. Under Chapter 11, a company continues to operate but is protected from creditors while it tries to work out a reorganization plan. At that time, the company’s management chose to accrue a $2.26 billion liability to reflect the potential cost of medical and life insurance benefits for its 118,000 current and retired employees, which was not required by generally accepted accounting principles. The Wall Street Journal reported that the company chose to recognize the charge because “if the company waited until after it negotiated new credit agreements and emerged from bankruptcy law proceedings before taking the $2 billion charge, the additional liability could trigger violations of its debt covenants.”
REQUIRED:
a. Provide the journal entry to record the $2.26 billion charge recognized by LTV.
b. Explain how taking the charge before negotiating new credit agreements could avoid violating debt covenants.
c. It was also reported that LTV took several other significant charges while it was under bankruptcy proceeding. In addition to its concern about debt covenants, in general, why might management have chosen to take these charges at this time?