Question

Prepare all the entries that would be made relative to sales of soap powder and to the premium plan in 2017. E13-13 (103) (Contingencies) Presented below are three independent situations. Answer the question at the end of each 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 a 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 wil compensate Etheridge for this destruction, but Etheridge has been assured by governmental officials that it will receive definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more the its book value. How should the contingency be reported in the financial statements of Etheridge Inc.?

Answer 1

1. When some amount within the range appears to be a better estimate than any other amount, that amount is recorded as liability. When no amount can be estimated properly, the amount at the low end of the range is recorded as liability and the dollar amount of the high end of the range is disclosed. In this case, therefore, Salt-n-Pepa Inc. would report a liability of $900,000 at December 31, 2017.

2. The loss should be accrued. The loss is covered by insurance, except for the $500,000 which is deductible. Thus only $500,000 should be accrued in the financial statements at December 31, 2017.

3. This is a case of contingent gain. The amount of compensation to be received is in excess of the book value of the plant. Contingent gains are not recorded and are disclosed only when the probabilities are high that such contingent gain will become reality.