For each independent situation: 1. A former employee of Melvin Minimarket Inc. sued the company for...

For each independent situation:

1. A former employee of Melvin Minimarket Inc. sued the company for $900,000, alleging that the company owner harassed her. Melvin's lawyers suggest that the lawsuit has a 30-40% probability of success and that, if successful, the plaintiff will be awarded between $400,000 and $500,000.

2. Leduc Pyrotechnics Ltd. received a $15,000 fee to guarantee the $800,000 bank indebtedness of Kenora Fireworks Inc. The fair value of the guarantee is initially estimated to be $15,000.

3. Montomery Syringes Co. sued a competitor for $800,000, alleging corporate espionage. Montomery's legal counsel believes that the company will be successful and will be awarded somewhere in the range of $650,000 to $800,000.

Required:

Describe how the event should be dealt with in the financial statements and explain why. Prepare all required journal entries.

Expert Solution

Question 1

$900,000 lawsuit for harrasmment will be a future liability to the company according to the outcome of the order. The company should test this contigent liability before reporting in the financial statements. For a contigent liability to be reported, it must be possible to estimate the value of the liability and there should be more than a 50% probability for the outcome. In this case there is only 30-40% probability. So the contigent liability should not be recorded in the financial statements.

Question 2

Guarantee provided to Kenora Fireworks Inc is a financial guarantee, as it requires Leduc Pyrotechnics Ltd to make reimbursement if Kenora Fireworks Inc defaults. Financial guarantee are recognized at their fairvalue. So debit fee received (probably cash) and credit liabilities from financial guarantee (shown under liability side).

Question 3

The award from lawsuit alleging corporate espionage is a contigent asset. Contigent assets will not be recognised until there is certainity of cash reaization. In this question the lawyer has a level of certainity regarding realization. So this asset will be recognized. Now taking into consideration the conservatism principle, the company should record a contigent asset of $650,000 (ie. the lower limit)

ekkarill92 answered 2 years ago

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