Question

The Heinrich Tire Company recalled a tire in its subcompact line in December 2018. Costs associated with the recall were originally thought to approximate $47 million. Now, though, while management feels it is probable the company will incur substantial costs, all discussions indicate that $47 million is an excessive amount. Based on prior recalls in the industry, management has provided the following probability distribution for the potential loss: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

Loss Amount			Probability
$	37	million	20%
$	27	million	50%
$	17	million	30%

An arrangement with a consortium of distributors requires that all recall costs be settled at the end of 2019. The risk-free rate of interest is 5%.

Required:
1. & 2. By the traditional approach to measuring loss contingencies, what amount would Heinrich record at the end of 2018 for the loss and contingent liability? For the remainder of this problem, apply the expected cash flow approach of SFAC No. 7. Estimate Heinrich’s liability at the end of the 2018 fiscal year.
3. to 5. Prepare the necessary journal entries.

Answer 1

Calculation of amount of loss That Heinrich woud Record
Loss Amount			Probability	Working	Expected Loss
$	37	million	0.2	37*0.20	7.40
$	27	million	0.5	27*0.50	13.50
$	17	million	0.3	17*0.30	5.10
			Expected Loss		26.00
	Contingent Liabilites
	Approximate recall Cost			47.00	Million
	Less Expected Loss			26.00	Million
	Contingent Liabilites			21.00	Million
	Liabilites at the year end 2018
	Expected Loss			26.00	Million
	Add: Intrest @5%			1.30	Million
	Net Liab			27.30	Million
	Intest Account Dr			1.3
	To Recall Cost				1.3