Question

Starfish Corporation, in preparation of its December 31, 2020, financial statements, is attempting to determine the proper accounting treatment for each of the following situations. 1. As a result of uninsured accidents during the year, personal injury suits for $261,000 and $697,000 have been filed against the company. It is the judgment of Starfish‘s legal counsel that an unfavorable outcome is unlikely in the $261,000 case but that an unfavorable verdict approximating $410,000 will probably result in the $697,000 case. 2. Starfish‘s deep sea exploration division consisting of operations in the Marina Trench is uninsurable because of the special risk of injury to employees and losses due to high pressure. The year 2020 is considered one of tinesafest (luckiest) in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of two casualties a year during the rest of the past decade (ranging from $25,000 to $1,000,000), management is certain that next year the company will probably not be so fortunate. 3. Starfish Corporation owns a subsidiary in a foreign country that has a book value of $21,600,000 and an estimated fair value of $30,890,000. The foreign government has communicated to Starfish its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Starfish expects to receive 60% of the fair value of its properties as final settlement.

1. What is the amount of legal expense recorded with respect to uninsured accidents?

2. Does Situation 1 warrant a footnote to the financial statements? 1=Yes, 0=No

(assume materiality)

Situation 2

3. What is amount of legal expense recorded with respect to special risk of injury to employees?

4. Does Situation 2 warrant a footnote to the financial statements? 1=Yes, 0=No

(assume materiality)

Situation 3

5. What is the amount of loss to record with respect to the expropriation of the foreign sub's assets?

6. Does Situation 3 warrant a footnote to the financial statements? 1=Yes, 0=No

(assume materiality)

Answer 1

Situation 1

1. What is the amount of legal expense recorded with respect to uninsured accidents?

• the amount of legal expense recorded with respect to uninsured accidents is $ 4,10,000.
• with respect to personal injury suits of $697,000 - As Before the financials were issued the contingency was occurred and can be estimated reliably . Therefore it is a contingent loss that provide additional evidence to conditions existed before financial statement issued and it met both criteria’s; hence, We can estimate the loss on the balance sheet and will credit the liability account.
• with respect to personal injury suits for $261,000 is unlikely to be unfavorable to the organization hence no need to be recognized as expense; foot note can be provided.

2. Does Situation 1 warrant a footnote to the financial statements? 1=Yes, 0=No

• 1=Yes; The notes should indicate $697,000 to reflect the suit for the uninsured accident during the period.
• and can also include personal injury suits for $261,000 for the better understanding of financial statement by the Stakeholders.

Situation 2

3. What is amount of legal expense recorded with respect to special risk of injury to employees?

• Nil; No entry should be made as no loss or injury occurred during the period

4. Does Situation 2 warrant a footnote to the financial statements? 1=Yes, 0=No

• 0=No; Nothing to record in the notes section since no loss or injury occurred during the period.

Situation 3

5. What is the amount of loss to record with respect to the expropriation of the foreign sub's assets?

• the amount of loss to record with respect to the expropriation of the foreign sub's assets is

Loss from expropriation = book value -  Amt expected to be recovered (60% of the fair value)

= $21,600,000 - 60% * $30,890,000

= $21,600,000 - $18,534,000

= $3,066,000

6. Does Situation 3 warrant a footnote to the financial statements? 1=Yes, 0=No

• 1=Yes; In the foot note section, the expropriation being imminent must be stated according to the letter from the foreign government. The asset cannot be written off completely since it has not been finalized yet.