Question

Late in 2021, you and two other officers of Curbo Fabrications Corporation just returned from a meeting with officials of the City of Jackson. The meeting was unexpectedly favorable even though it culminated in a settlement with city authorities that required your company pay a total of $475,000 to cover the cost of violations of city construction codes. Jackson had filed suit in November 2019 against Curbo, seeking civil penalties and injunctive relief for violations of city construction codes regulating earthquake damage standards. Alleged violations involved several construction projects completed during the previous three years. When the financial statements were issued in 2020, Curbo had not reached a settlement with state authorities, but legal counsel had advised the Company that it was probable the ultimate settlement would be $750,000 in penalties. The following entry had been recorded: 

Loss—litigation ................................................................................................ 750,000 

Liability—litigation ...................................................................................... 750,000

The final settlement, therefore, was a pleasant surprise. While returning from the meeting, your conversation turned to reporting the settlement in the 2021 financial statements. You drew the short straw and were selected to write a memo to Janet Zeno, the financial vice president, advising the proper course of action. 

 

Required: 

Write the memo. Include descriptions of any journal entries related to the change in amounts. Briefly describe other steps Curbo should take to report the settlement.

Answer 1

Likelihood of event:

Probable: It denotes an event which is confirm and likely to occur.

Reasonably possible: probability of occurrence of conforming event is more than remote but less than likely.

 

Remote: The likelihood of occurrence of event is very low.

 

To,

The official,

Curbo fabrication corporations

 

Sub: Opinion on treatment of amount of law suit

 

Dear sir,

As the amount of liability is reduced, it denotes gain contingency. It is should be reported as follows.

 

Journal entry for recording of change:

Particulars	Debit	Credit
Liability-Litigation	$475,000
Gain-litigation		$475,000
(To record gain contingency)

 

Explanation:

Liabilities are always credited as rule. To denote change in liability or to reduce liability, it should be debited with respective amount to write off balance. As the settlement is reached with less amount to be paid, the gain should be credited as per rule credit all income or gains and debit all expenses.

 

The probable ultimate settlement in penalties is $750,000, now it is $475,000.

 

A disclosure note is required to show change in estimated amount of liability finally settled.

From

Janet Zeno

Likelihood of event:

Probable: It denotes an event which is confirm and likely to occur.

Reasonably possible: probability of occurrence of conforming event is more than remote but less than likely.