Question

Lincoln Chemicals became involved in investigations by the U.S. Environmental Protection Agency in regard to damages connected to waste disposal sites. Below are four possibilities regarding the timing of (A) the alleged damage caused by Lincoln, (B) an investigation by the EPA, (C) the EPA assessment of penalties, and (D) ultimate settlement. In each case, assume that Lincoln is unaware of any problem until an investigation is begun. Also assume that once the EPA investigation begins, it is probable that a damage assessment will ensue and that once an assessment is made by the EPA, it is reasonably possible that a determinable amount will be paid by Lincoln. 

 

Required: 

For each case, decide whether (1) a loss should be accrued in the financial statements with an explanatory note, (2) a disclosure note only should be provided, or (3) no disclosure is necessary. 

Answer 1

Case 2:

The following case depicts of an adjusting event as the investigation by EPA has begun till the date the financial statements have been issued.

 

Thus it can be determined that the alleged damage which was caused by the company before the balance sheet date implies that the conditions were pre-existing on the balance sheet date. So the damage assessment can be ensured but the probability of the outcome and the liability arising in this case cannot be accurately determined. Thus a disclosure note has to be given in the financial statements as to identify this as a contingent liability.

 

The correct option in this case will be (b).

 

Case 3:

The following case depicts of an event which is adjusting as the damage which is being caused by the company have pre-existed on the balance sheet date.

 

The ultimate settlement have been done before the issuance of the financial statements .So the loss which is identified should be accrued in the financial statement along with an explanatory note for the same to be identified as a loss of damage .

 

The correct option in this case will be (a).

 

Case 4:

The following case depicts of the event of damage for which the investigation have begun after the financial statements were issued.

 

So the following event should be identified as which needs neither disclosure requirement nor any accrual of liability in the balance sheet.

 

The correct option in this case will be (c).

Case 2:

The following case depicts of an adjusting event as the investigation by EPA has begun till the date the financial statements have been issued.