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Chapter 11: Q12SE (page 606)

Freeman Motors, a motorcycle manufacturer, had the following contingencies.

a. Freeman estimates that it is reasonably possible but not likely that it will lose a current lawsuit. Freeman鈥檚 attorneys estimate the potential loss will be \(4,500,000.

b. Freeman received notice that it was being sued. Freeman considers this lawsuit to be frivolous.

c. Freeman is currently the defendant in a lawsuit. Freeman believes it is likely that it will lose the lawsuit and estimates the damages to be paid will be \)75,000.

Determine the appropriate accounting treatment for each of the situations Freeman is facing.

Short Answer

Expert verified

A contingency is a possibly undesirable future occurrence, such as a natural disaster, fraudulent conduct, or economic recession.

Step by step solution

01

Answer of part a.

Freeman's estimation of reasonably possible to lose a current lawsuit is $4,500,000. This possible contingency should be described in the notes to the financial statements.

02

Answer of part b.

Freeman received notice of a frivolous lawsuit. This is a remote contingency. The company does not need to record a liability and does not need to disclose it in the notes to the financial statements.

03

  Step 3: Answer of part c.

Freeman is currently the defendant in a lawsuit. If he loses estimates, the damages to be paid will be $75,000. These contingencies that are probable and can be estimated are recorded as a liability and an expense accrued.

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