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Eastern Manufacturing is involved with several situations that possibly involve contingencies. Each is described below. Eastern’s fiscal year ends December 31, and the 2016 financial statements are issued on March 15, 2017.
| a. | Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2017, judgment was rendered against Eastern in the amount of $119 million plus interest, a total of $134 million. Eastern plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company. |
| b. | In November 2015, the State of Nevada filed suit against Eastern, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2017, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $152 million will be required to cover the cost of violations. Eastern believes that the ultimate settlement of this claim will not have a material adverse effect on the company. |
| c. | Eastern is the plaintiff in a $212 million lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Eastern will prevail and be awarded $120 million. |
| d. | At March 15, 2017, Eastern knows a competitor has threatened litigation due to patent infringement. The competitor has not yet filed a lawsuit. Management believes a lawsuit is reasonably possible, and if a lawsuit is filed, management believes damages of up to $45 million are reasonably possible.
Prepare the appropriate journal entries for these situations. 1. Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2017, judgment was rendered against Eastern in the amount of $119 million plus interest, a total of $134 million. Eastern plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company. 2.In November 2015, the State of Nevada filed suit against Eastern, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2017, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $152,000,000 million will be required to cover the cost of violations. Eastern believes that the ultimate settlement of this claim will not have a material adverse effect on the company. 3.Eastern is the plaintiff in a $212 million lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Eastern will prevail and be awarded $120 million. 4.At March 15, 2017, Eastern knows a competitor has threatened litigation due to patent infringement. The competitor has not yet filed a lawsuit. Management believes a lawsuit is reasonably possible, and if a lawsuit is filed, management believes damages of up to $45 million are reasonably possible. |
Expert Answer
Situation# 1
Solution: This represents a loss contigency.On the basis of the information, eastern is not able to depict the outcome of the appeal.Additionally, the result is not anticipated to have a material unfavorable effect on the company.Therefore, Eastern would not register $122 million loss.It would however provide a revelation note.
Situation # 2
Solution: Thisrepresents a loss contingency. Since it is foreseeable that Eastern would have to pay $140 million, which can be rationally evaluated, Eastern should register the loss and related liability, and provide a footnote revelation that details the nature of lawsuits and the loss.
Litigation loss Dr. 140000000
To litigation liabilitiy…………….140000000
Situation #3
Solution: This is a gain contingency.Gain contingencies are not accumulated even if the gain is foreseeable and fairly estimable.The gain should beacknowledged only when perceived. though gain contingencies are not registered in the accounts, they should be in notes to the accounting statements.
Situation #4
Solution: No disclosure is needed as an IRS claim is as yet not maintained, and an evaluation is not foreseeable. Even if an adverse result is thought to be foreseeable in the event of an evaluation and the amount is predictable, declaration is not required unless an unasserted claim is likely.
