Question

Great Adventures is a defendant in litigation involving a biking accident during one of its adventure races. The front tire on one of the bikes came off during the race, resulting in serious injury to the rider. However, Great Adventures can document that each bike was carefully inspected prior to the race. It may have been that the rider loosened the wheel during the race and then forgot to tighten the quick-release mechanism.

For each of the following scenarios, record the necessary entry. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

Required:

1. The likelihood of a payment occurring is probable, and the estimated amount is $111,000.

2. The likelihood of a payment occurring is probable, and the amount is estimated to be in the range of $91,000 to $141,000.

3. The likelihood of a payment occurring is reasonably possible, and the estimated amount is $111,000.

4. The likelihood of a payment occurring is remote, while the estimated potential amount is $111,000.

Answer 1

Contingent Liability:

A Contingent Liability is A) a possible obligation that arises from past events and the existence of which will be confirmed only by occurence or non occurence of one or more uncertain events not within the control of the enterprise B) a present obligation that arises from past events but is not recognised because it is not probable that an outflow of resources emboyding economic benefits wiil be required to settle the obligation or a reliable estimate of the obligation cannnot be made.

An enterprise should recognise Contingent Liability only if contingency is probable and amount of liability can be reasonably estimated. If such conditions are not met , it should only be disclosed.  

A possible obligation is always a Contingent Liability whereas present obligation becomes contingent if recognition criteria is not satisfied.

Examples of Contingent Liability involves Lawsuit, Income tax disputes,Guarantee of debt etc.

Answer to 1:

The likelihood of payment occuring is probable and the estimated amount is $1,11,000

The loss and liability should be recorded based on estimated amounts.

As the contingency is probable and the amount of expense can be estimated, then expense should be recorded based on estimated amount. In the above situation the Company has estimated the expense of $1,11,000 and so the expense of $1,11,000 should be recorded.

Accounting Equation:

Asset = Liability + Shareholder's Equity

= $1,11,000(Estimated Liability) - $1,11,000(Loss)

  

Date	Account & Explanation	Debit($)	Credit($)
	Loss A/c Dr.	1,11,000
	To, Estimated Liability		1,11,000
	( Being Contingent Liability Recorded)

Answer to 2:

The likelihood of payment occuring is probable and the estimated amount is in the range of $ 91,000 to $1,41,000

The loss and liability should be recorded based on minimum estimated amounts. The range of amount should be discosed in the footnote of Financial Statements.

As the contingency is probable and the amount of expense can be estimated, then expense should be recorded based on estimated amount. In the above situation the Company has estimated the expense in the range of $ 91,000 to $1,41,000 and so the expense of minimum range $91,000 should be recorded and range of amount should be disclosed in footnotes of Financial Statements.

Accounting Equation:

Asset = Liability + Shareholder's Equity

= $91,000(Estimated Liability) - $91,000(Loss)

Date	Account & Explanation	Debit($)	Credit($)
	Loss A/c	$91,000
	To, Estimated Liability		$91,000
	(Being Contingent Liabilty recorded)

Answer to 3:

Likelihood of payment occuring is reasonabaly possible:

If the contingent liability is reasonably possible, then it should be disclosed in notes to Financial Statements. The above pertains to  reasonably possible so it should be disclosed in notes to Financial Statements

Answer to 4:

Likelihood of payment occuring is remote:

The Company does not need to record the liability nor does it needs to disclose it in Financial Statements for remote event.

The above situation is applicable only for remote situation.