/*! This file is auto-generated */ .wp-block-button__link{color:#fff;background-color:#32373c;border-radius:9999px;box-shadow:none;text-decoration:none;padding:calc(.667em + 2px) calc(1.333em + 2px);font-size:1.125em}.wp-block-file__button{background:#32373c;color:#fff;text-decoration:none} 13E (Contingencies) Presented below ... [FREE SOLUTION] | 91影视

91影视

Log out

Learning Materials

Features

Discover

Chapter 13: 13E (page 658)

(Contingencies) Presented below are three independent situations. Answer the question at the end of each situation:

1. During 2017, Salt-n-Pepa Inc. became involved in a tax dispute with the IRS. Salt-n-Pepa鈥檚 attorneys have indicated that they believe it is probable that Salt-n-Pepa will lose this dispute. They also believe that Salt-n-Pepa will have to pay the IRS between \(900,000 and \)1,400,000. After the 2017 financial statements were issued, the case was settled with the IRS for \(1,200,000. What amount, if any, should be reported as a liability for this contingency as of December 31, 2017?

2. On October 1, 2017, Alan Jackson Chemical was identified as a potentially responsible party by the Environmental Protection Agency. Jackson鈥檚 management along with its counsel have concluded that it is probable that Jackson will be responsible for damages, and a reasonable estimate of these damages is \)5,000,000. Jackson鈥檚 insurance policy of \(9,000,000 has a deductible clause of \)500,000. How should Alan Jackson Chemical report this information in its financial statements at December 31, 2017?

3. Melissa Etheridge Inc. had a manufacturing plant in Sudan, which was destroyed in the civil war. It is not certain who will compensate Etheridge for this destruction, but Etheridge has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more than its book value. How should the contingency be reported in the financial statements of Etheridge Inc.?

Short Answer

Expert verified
  1. $900,000will be reported as contingency liability.
  2. $5,000,000will get accrued as a contingent liability.
  3. Excess of the amount received over the book value will be reported as contingency gain.

Step by step solution

01

Definition of Contingency Liability

Occurrence of liability which is based on the happening of a uncertain event or transaction in the future is known as contingency liability. It is reported only when accountant are able to measure the liability in monetary term reasonably.

02

Amount reported as contingency liability as of December 31, 2017

According to the principles stated by FASB, the business entity must record the best estimate of the liability in the contingency. If a range of liability is estimated and there is no better estimate, the business entity must accrue the lower end of the range of liability estimated. Therefore, Salt-n-Pepa Inc would report a contingency of $900,000 on 31 December 2017.

03

Reporting by Alan Jackson in the financial statements

The business entity has a reasonable estimate of the damages of $5,000,000. Therefore, $5,000,000 must be accrued as contingency liability. The amount that will be recovered from the insurance is the gain contingency that will be recorded when it is received.

04

Reporting contingency in the financial statement

This will be reported as contingency gain because the business entity has estimated that the amount received will be more than the book value of the plant. Such gain is not recorded when the probability of the gain is high, instead, it must be recorded when it is received.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with 91影视!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

E13-5 (L01) (Adjusting Entry for Sales Tax) During the month of June, Rowling Boutique recorded cash sales of \(233,200 and credit sales of \)153,700, both of which include the 6% sales tax that must be remitted to the state by July 15.

Instructions

Prepare the adjusting entries that should be recorded to fairly present the June 30 financial statements.

You are the independent auditor engaged to audit Millay Corporation鈥檚 December 31, 2017, financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following contingent liabilities.

  1. Millay began production of a new dishwasher in June 2017 and, by December 31, 2017, sold 120,000 to various retailers for \(500 each. Each dishwasher is under a 1-year warranty. The company estimates that its warranty expense per dishwasher will amount to \)25. At year-end, the company had already paid out \(1,000,000 in warranty expenses. Millay鈥檚 income statement shows warranty expenses of \)1,000,000 for 2017. Millay accounts for warranty costs on the accrual basis.
  2. In response to your attorney鈥檚 letter, Morgan Sondgeroth, Esq., has informed you that Millay has been cited for dumping toxic waste into the Kishwaukee River. Clean-up costs and fines amount to \(2,750,000. Although the case is still being contested, Sondgeroth is certain that Millay will most probably have to pay the fine and clean-up costs. No disclosure of this situation was found in the financial statements.
  3. Millay is the defendant in a patent infringement lawsuit by Megan Drabek over Millay鈥檚 use of a hydraulic compressor in several of its products. Sondgeroth claims that, if the suit goes against Millay, the loss may be as much as \)5,000,000. However, Sondgeroth believes the loss of this suit to be only reasonably possible. Again, no mention of this suit is made in the financial statements.

As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers.

Instructions

Heading each page with the name of the company, balance sheet date, and a brief description of the problem, write a brief narrative for each of the above issues in the form of a memorandum to be incorporated in the audit work papers. Explain what led to the discovery of each problem, what the problem really is, and what you advised your client to do (along with any appropriate journal entries) in order to bring these contingencies in accordance with GAAP.

(Warranties) Brooks Corporation sells computers under a 2-year warranty contract that requires the corporation to replace defective parts and to provide the necessary repair labor. During 2017, the corporation sells for cash 400 computers at a unit price of \(2,500. On the basis of past experience, the 2-year warranty costs are estimated to be \)155 for parts and \(185 for labor per unit. (For simplicity, assume that all sales occurred on December 31, 2017.) The warranty is not sold separately from the computer.

Instructions

(a) Record any necessary journal entries in 2017.

(b) What liability relative to these transactions would appear on the December 31, 2017, balance sheet and how would it be classified?

(c) In 2018, the actual warranty costs to Brooks Corporation were \)21,400 for parts and $39,900 for labor. Record any necessary journal entries in 2018.

Question: Distinguish between debt security and equity security.

How are the terms 鈥減robable,鈥� 鈥渞easonably possible,鈥� and 鈥渞emote鈥� related to contingent liabilities?
See all solutions

Recommended explanations on Business Studies Textbooks

Corporate Finance

Read Explanation

Accounting

Read Explanation

Insurance

Read Explanation

Intermediate Accounting

Read Explanation

Human 91影视

Read Explanation

Organizational Communication

Read Explanation
View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.