13:13 Contingencies
13. (Contingencies) Presented below are three independent situations. Answer the question
at the end of each situation.
1. During 2004, Salt-n-Pepa Inc. became involved in a tax dispute with the IRS.
Salt-n-Pepa's attorneys have indicated that they believe it is probable that
Salt-n-Pepa will lose this dispute. They also believe that Salt-n-Pepa will have to
pay the IRS between $900,000 and $1,400,000. After the 2004 financial statements
were issued, the case was settled with the IRS for $1,200,000. What amount, if
any, should be reported as a liability for this contingency as of December 31, 2004?
2. On October 1, 2004, Alan Jackson Chemical was identified as a potentially
responsible party by the Environmental Protection Agency. Jackson's management
along with its counsel have concluded that it is probable that Jackson will be
responsible for damages, and a reasonable estimate of these damages is $5,000,000.
Jackson's insurance policy of $9,000,000 has a deductible clause of $500,000. How
should Alan Jackson Chemical report this information in its financial statements
at December 31, 2004?
3. Melissa Etheridge Inc. had a manufacturing plant in Bosnia, which was destroyed
in the civil war. It is not certain who will compensate Etheridge for this destruction, but Etheridge has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more than its book value. How should the
contingency be reported in the financial statements of Etheridge Inc.?
The problem discusses the three different situations on contingencies and what is the correct approach to deal with these situations. The solution refers to the FASB and other guidelines to estimate the reported liability for the contingency.
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