Question

Authors Academic Press faces three potential contingency situations, described below. Authors’ fiscal year ends December 31, 2021.

 

Required:

Determine the appropriate means of reporting each situation for the year ended December 31, 2021, and record any necessary entries. Explain your reasoning.

1. In August 2021, a worker was injured in an accident, partially as a result of his own negligence. The worker has sued the company for $1.2 million. Legal counsel believes it is reasonably possible that the outcome of the suit will be unfavorable, and that the settlement would cost the company from $300,000 to $600,000.

2. A suit for breach of contract seeking damages of $3 million was filed by an author on October 4, 2021. Legal counsel believes an unfavorable outcome is probable. A reasonable estimate of the award to the plaintiff is between $1.5 million and $2.25 million. No amount within this range is a better estimate of potential damages than any other amount.

3. Authors is the plaintiff in a pending court case. Its lawyers believe it is probable that Authors will be awarded damages of $3 million.

Answer 1

Determine the appropriate means of reporting each situation for the year ended December 31, 2012:

The appropriate means of reporting in the given case is reporting of transactions in the balance sheet and the notes accompanying the preparation of financial statements. The reporting of given situations includes the reporting the transactions as contingent liability.

A contingent liability is a potential obligation that may or may not be incurred depending as a result of the outcome of a future event. A contingent liability will arise where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event. A contingent liability should be reported if it is both probable and the amount can be estimated is recorded.

The contingent liability is recorded as (1) an expense or loss on the income statement, and (2) a liability on the balance sheet.

 

Now determine the appropriate means of reporting as below:

 

(1)

A contingent liability is a potential obligation that may or may not be incurred depending as a result of the outcome of a future event. A contingent liability will arise where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event. In the present case, the loss is not probable. Hence, no journal entry is required for the loss and liability.

However, appropriate disclosure with a description to the loss contingency to should be provided in the notes accompanying the financial statements.

 

(2)

A contingent liability is a potential obligation that may or may not be incurred depending as a result of the outcome of a future event. A contingent liability will arise where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event. In the present case, the contingent liability is probable and can be estimated reasonably. Hence, in order to report the same, a journal entry is required for the loss and liability, by debiting loss and crediting contingent liability.

Date	Account title	Debit ($)	Credit ($)
	Loss	1,000,000
	Contingent liability		1,000,000
	[To record the loss contingency.]

 

 

(3)

From the given information, it is clear that A A Publishing has a probable contingent gain that can be estimated reasonably at $2 million. However, contingent gains cannot be recorded unless they are certain.

These contingent gains should be disclosed in the notes to the financial statements.

These contingent gains should be disclosed in the notes to the financial statements.