Question

Contingent Liabilities

Several months ago, Cinnabar Chemical Company experienced a hazardous materials spill at one of its plants. As a result, the Environmental Protection Agency (EPA) fined the company $1,416,000. The company is contesting the fine. In addition, an employee is seeking $342,000 damages related to injuries sustained while cleaning up the spill. Lastly, a homeowner has sued the company for $236,000. The homeowner lives 15 miles from the plant but believes that the incident has reduced the home's resale value by $236,000.

Cinnabar’s legal counsel believes that it is probable that the EPA fine will stand. In addition, counsel indicates that an out-of-court settlement of $213,750 has recently been reached with the employee. The final papers will be signed next week. Counsel believes that the homeowner's case is much weaker and will be decided in favor of Cinnabar. Other litigation related to the spill is possible, but the damage amounts are uncertain.

a. Illustrate the effects of the contingent liabilities associated with the hazardous materials spill on the accounts and financial statements. If no account or activity is affected, select "No effect" from the dropdown list and leave the corresponding number entry box blank. Enter account decreases and cash outflows as negative amounts

Statement of Cash Flows Balance Sheet Income Statement Assets = Liabilities + Stockholders' Equity Statement of Cash Flows Income Statement

Answer 1

The contingent liabilities will be recorded in financial books if the probability is high and the amount can be accurately estimated

The journal entry will be made for EPA fine as it is probable that Cinnabar Chemical Company will pay the fine

General Voucher
Date	Account title and Explanation	Post. Ref.	Debit ($)	Credit ($)
	Damages awards and fine expense		1,416,000
	EPA fines payable			1,416,000
	( to book contingent liability of EPA fines most likely to be paid by company)

The damages awards and fine expense is expense account and will reflected in income statement and will shown in negative amount and in balance sheet will be shown retained earnings in owners’ equity as negative amount

The EPA fines payable will shown in liability side of balance sheet

There will be no impact in statement of Cash flow as no amount is paid

The journal entry will be made for that an out-of-court settlement of $213,750 has recently been reached with the employee

General Voucher
Date	Account title and Explanation	Post. Ref.	Debit ($)	Credit ($)
	Damages awards and fine expense		213,750
	Litigation claims payable			213,750
	( to book contingent liability litigation of employee as out of court settlement is done by company)

The damages awards and fine expense is expense account and will reflected in income statement and will shown in negative amount and in balance sheet will be shown retained earnings in owners’ equity as negative amount

The Litigation claims payable will shown in liability side of balance sheet

There will be no impact in statement of Cash flow as no amount is paid

	Balance sheet
statement of cash flows	Assets	=	Liabilities			+	Stockholders's Equity		income statement
	no effect		EPA FINES PAYABLE	+	Litigation claims payable	+	Retained Earnings
	0		1,416,000		213,750		-1,629,750
statement of Cash flows							Income Statement
no effect
							Damages awards and fines expenses		-1,629,750