Question

Use the information below to determine the correct accounting treatment of the contingent liability described. Select treatment A, B, or C below and record your answers in Blackboard.
A. B. C.	Record a liability Disclose the liability in a footnote to the financial statements Neither record nor disclose the liability
Camo Max manufactures camouflage apparel for paintball enthusiasts. In the normal course of business, the company encounters various situations giving rise to contingencies. Evaluate the following situations and prepare an explanation of the appropriate accounting considerations for each.
1	The company is subject to several lawsuits by plaintiffs. These claims assert that the camouflage is so effective that opposing paintballers come into too close of a range, and are therefore hurt by high-velocity, close-up shots. The company's attorney views the likelihood of any adverse judgment as highly remote. Further, the company generally has seen increased sales because of publicity associated with these claims.
2	The company manufactures a face shield that has been prone to crack. As a result, several serious injuries have been reported. The company is generally willing to settle each documented claim for $20,000. Currently, it is estimate that 45 such claims will be submitted and settled.
3	The company has issued a full product recall of the defective face shields, and expects to spend $700,000 on issuing replacement shields. The new shields will not be distributed until the next fiscal year.
4	The company has been notified by a competitor that one of Camo Max's camouflage designs violates a copyright held by the competitor. The competitor is asking for a $250,000 paid up license to the use the design. Camo Max disagrees, but believes that it is reasonably possible the competitor will file and win on a copyright infringement action.
5	Subsequent to year end (but before preparing financial statements), an employee was seriously injured by a fabric cutting machine. The company has agreed to a large financial settlement with the employee. This payment will eliminate any hope of profitability during the next several years.

Answer 1

Answer	Option	Explanation
1	B - Disclose the liability in a footnote to the financial statements	If the contingent loss is remote, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before the value could be determined should be disclosed in the footnote to financial statements.
2	A - Record a liability	The claim is probable and subject to reasonale estimation i.e., 45 x 20000 = $900,000. Hence, it should be recorded as a liability.
3	A - Record a liability	The claim is probable and subject to reasonale estimation i.e.,$700,000. Hence, it should be recorded as a liability.
4	A - Record a liability	The company is expecting a claim of $250,000 and hence the liability should be recorded in the balance sheet.
5	B - Disclose the liability in a footnote to the financial statements	There is no financial estimate of the liability but it is certain to downgrade the future profits. Hence a footnote about the same has to be a part of the financial statements.