Question

Koll's Company is preparing its annual financial statements at December 31, 2020. During 2020, a customer fell while riding on the escalator and has filed a lawsuit for $150,000 because of a claimed back iniury. The lawver employed by the company has carefully assessed all of the implications. If the suit is lost their attomey's reason able estimate is that the $150,000 will be assessed by the court. Exercise 15-64 Heporting Ligation Contingencies L05 Required How should the contingency be handled during 2020 in each of the following cases? Provide all necessary entries and any necessary disclosures. a. Assume that the attorney and the management concluded that it is reasonably possible that the company will be liable. b. Assume instead, that the attorney, the independent accountant, and management have reluctantly concluded that it is probable that the suit will be successful. c. Assume that the conclusion of the legal counsel and management is that the chance of a contingency loss is remote. They believe the suit is without merit. d. Assume that the company decided to accrue a loss of $150,000 in 2020 based upon their assessment. Howev- er, in 2021, the suit was settled for $175,000. How would this change be treated in the financial statements?

Answer 1

Assumptions and the treatment

a) Assume that attorney and the management concluded that it is reasonable possible that the company will be liable

Treatment: In this case Koll's Company should provide it in expenses side of the income statement as Compensations and losses and make provision in the balance sheet for it.

b) Assume instead, that the attorney, the independent accountant, and management have reluctantly concluded that it is probable that suit will be successful.

Treatment: In this case also Koll's Company should provide it in expenses side of the income statement as Compensations and losses and make provision in the balance sheet for it.

c) Assume that the conclusion of the legal counsel and management is that chance of a contingency loss is remote. They believe the suit is without merit

Treatment: In this case Koll's Company not require to account the liability but it should be shown as a foot note in the financial statements.

d) Assume that the company decided to accrue a loss of $15000 in 2020 based upon their assessment. However in 2021, the suit was settled for $175000.

Treatment:

In 2020, Koll's Company should provide $150000 in expenses side of the income statement as Compensations and losses and make provision in the balance sheet for $150000.

In 2021, Koll's Company should book $25000 as expenses in the income statement as Compensations and losses and make and make payment to claimer. Following will be journal entry:

Provision for Compensations A/c Dr. 150000

Compensation losses A/c    Dr. 25000

   To Bank A/c Cr. 175000

(Being $175000 paid towards compensation of a law suit against provision of $150000)