Question

Instructions Prepare all the entries that would be made relative to sales of soap powder and to the premium plan in 2017. E13-13 (LO3) (Contingencies) Presented below are three independent situations. Answer the question at the end of cach situation. 1. During 2017, 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 2017 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, 2017? 2. On October 1, 2017, Alan Jackson Chemical was identified as a potentially responsible party by the Environmental Protec- tion Agency. Jackson's management along with its counsel have concluded that it is probable that Jackson will be respon- sible 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, 2017? 3. Melissa Etheridge Inc. had a manufacturing plant in Sudan, 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.?

Answer 1

Part 1

Contingency liability = $900,000

According to FASB, if it is possible to get better estimated from the range of expected loss then that amount is considered to be accrued and in case of no better estimate, the amount at the lowest end of the range is considered to be accrued whereas the amount at the highest end is to be disclosed. Hence, the liability of $900000 is reported by Salt-n-Pepa Inc. at December 31, 2017.

Part 2

Loss accrued = $5,000,000

The potential insurance recovery is considered as a gain contingency and gain contingency is not recorded until it is actually received.

Part 3

No contingency should be reported in the financial statements of Etheridge Inc.

The amount that will be received is going to be higher than the book value of the plant and thus it is considered a gain contingency. Gain contingency is not recorded until it is actually received. It is just disclosed.