Question

Winger Airlines Co. has been sued by Schock Electronics, Inc. for $50,000. Attorneys for Schock Electronics, Inc. are confident that Schock will win the case and will be awarded the full amount. Attorneys for Winger Airlines Co. agree that Winger will probably lose the case and be required to pay the full amount.

a. What is the correct treatment of this loss contingency for Winger Airlines Co.’s financial statements? Show any related journal entry.

b. How should Schock Electronics, Inc. treat this gain contingency for financial statement purposes? Show any related journal entry.

2. (1 point) How should Schock Electronics, Inc. treat this gain contingency for financial statement purposes? Show any related journal entry.

Answer 1

Ans. A. Accounting treatment for Winger Airlines Co.:

As per conservatism principle, all expected losses must be recorded immediately and all expected gains must not be recorded until accrued. Since the contingent loss here is probable and the amount of loss can be fairly estimated ($50,000), this contingent loss must be recorded in the financial statements of Winger Airlines Co. by way of following journal entry:

Law Suit Loss A/c          Dr.                      $50,000

To Law Suit Liability                                                     $50,000

Ans. B. Accounting treatment for Schock Electronics Inc.:

Following the conservatism principle, the contingent gain will not be recorded in the financial statements of Schock Electronics Inc. since it is yet not accrued. However, since the gain is probable and amount can be estimated, the same can be included as notes to the financial statements.

No journal entry is required.