Question

The ink-jet printing division of Environmental Printing has grown tremendously in recent years. Assume the following transactions related to the ink-jet division occur during the year ended December 31, 2021.

 

Required:

Record any amounts as a result of each of these contingencies.

1. Environmental Printing is being sued for $11 million by Addamax. Plaintiff alleges that the defendants formed an unlawful joint venture and drove it out of business. The case is expected to go to trial later this year. The likelihood of payment is reasonably possible.

2. Environmental Printing is the plaintiff in an $9 million lawsuit filed against a competitor in the high-end color-printer market. Environmental Printing expects to win the case and be awarded between $6.5 and $9 million.

3. Environmental Printing recently became aware of a design flaw in one of its ink-jet printers. A product recall appears probable. Such an action would likely cost the company between $500,000 and $900,000.

Answer 1

Contingent liabilities:

Contingent liabilities are those liabilities which arise in future due to an uncertain event and depending on the uncertainty belonging to the future. These types of liabilities are classified as a current liability which is shown under the balance sheet as a liability.

 

(1)

A contingent liability is recorded only when the likelihood of its payment is probable and the amount of liability can be estimated reliably.

In the given problem, E Printing Company has been sued for forming an unlawful joint venture, for an amount of $11 million. The likelihood of payment is reasonably possible and the amount has been calculated on the basis of estimation.

Since, the likelihood of payment is reasonably possible and not probable; no contingent liability will be recorded in the books of accounts. Only a disclosure of such liability will be made in the financial statements.

 

(2)

E Printing Company has filed a suit against a competitor, which the company is expecting to win and be awarded an amount between $6.5 million and $9 million. It is a contingent gain which is dependent on the outcome of lawsuit.

A contingent gain is recorded only when it becomes certain and no longer remains a contingent gain. In other words, it is recorded only after its dependency on an uncertain event end.

Since, the amount of gain has not yet become certain and is dependent upon the outcome of lawsuit, being an uncertain event; no contingent gain needs to be recorded in the books of accounts.

 

(3)

It has been found by the company that there is some design flaw in one of its ink-jet printers, which is expected to result in a product recall, costing the company an amount between $500,000 and $900,000.

A contingent liability is recorded only when the chance of its occurrence is probable and the amount can be estimated reliably.

Since, the amount cannot be estimated reliably, no contingent liability will be recorded in the books of accounts. Only a disclosure of such liability will be made in the financial statements.

Since, the amount cannot be estimated reliably, no contingent liability will be recorded in the books of accounts. Only a disclosure of such liability will be made in the financial statements.