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23E

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Horngren'S Financial And Managerial Accounting
Found in: Page 609

Short Answer

Accounting treatment for contigencies

Analyze the following independent situations.

  1. Weaver, Inc. is being sued by a former employee. Weaver believes that there is a remote chance that the employee will win. The employee is suing weaver for damages of $40.000.
  2. Gulf Oil Refinery had a gas explosion on one of its oil rigs. Gulf believes it is likely that it will have to pay environmental clean-up costs and damages in the future due to the gas explosion. Gulf cannot estimate the amount of the damages.
  3. Lawson Enterprises estimates that it will have to pay $75,000 in warranty repairs next year.

Determine how each contingency should be treated.

a) Do not disclose.

b) Disclose the situation in the footnotes to the financial statements.

c) Expense and liability should be recorded based on estimated amounts.

See the step by step solution

Step by Step Solution

Step 1: Meaning of contingency liability

It is a possible liablity for a business that depends on a upcoming circumstance. It is the outcome for an forseen circumstance. A future event must take place to pay a contingent responsibility. The possibility of an incident occuring in the future is considered while registering a contingent obligation.

  • Remote
  • Reasonable prospects
  • Probable

Step 2: (a) Analyzing the independent situation

Accounting treatment: Do not disclose.

If the obligation is related to an issolated occurence, the Company is not required to record it or disclose it in the financial statement's notes. Since the liability in this instance relates to an isolated incident, it is not necessary to disclose it.

Step 3: (b) Analyzing  the independent situation

Accounting treatment: Disclose the situtaion in the footnotes to the financial statements.

An obligation should be declared in the notes to the financial statements if it is probably contingent and cannot detemine the expense amount. Here, the scenario is likely, and the corporation hasn't calculated the cost of the harm. As a reult, a remark should be addee to the financial statements to explain the situation.

Step 4: (c) Analyzing the independent situation

Accounting treatment: Expense and liability should be recorded based on estimated amounts.

If a cost anticipated and an obligation falls beneath a likely possibility, the cost and liability should be detailed utilizing the projected sum. The corporation has calculated the damage (cost) in this case to be $75,000; then should document the expense of $75,000.

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