Howell Incorporated Current Income Statement and December 31 Balance Sheet

Essay

Howell Incorporated current income statement and December 31 balance sheet follow: During an audit of Howell's current financial statements, its auditor discovered that Howell is a defendant in a $20,000 lawsuit for infringement of patent rights. Howell's management, under the advice of its legal counsel, decided that it was only reasonably probable that they would lose the suit and have to pay $20,000. However, its auditor disagreed with the treatment of the contingent loss and effectively argued that it is probable that the lawsuit will require Howell to pay $20,000 in the forthcoming year. The management of Howell decided to "take a bath" and treat the $20,000 lawsuit consistent with GAAP on probable conditional liabilities.
A. Reconstruct Howell current income statement and 12/31 balance sheet under the auditor's judgment concerning the $20,000 lawsuit
B. Calculate and compare current, debt/equity, and debt/asset ratios resulting from Howell's initial and reconstructed financial statements. Comment on Howell's solvency.