Several months ago, Welker Chemical Company experienced a hazardous ma-terials s

Question

Several months ago, Welker Chemical Company experienced a hazardous ma-terials spill at one of its plants. As a result, the Environmental Protection Agency ( EPA) fined the company $ 410,000. The company is contesting the fine. In ad-dition, an employee is seeking $ 400,000 damages related to the spill. Lastly, a homeowner has sued the company for $ 260,000. The homeowner lives 30 miles from the plant, but believes that the incident has reduced the home’s resale value by $ 260,000.

Welker’s legal counsel believes that it is probable that the EPA fine will stand. In addition, counsel indicates that an out- of- court settlement of $ 170,000 has recently been reached with the employee. The final papers will be signed next week. Counsel believes that the homeowner’s case is much weaker and will be decided in favor of Welker. Other litigation related to the spill is possible, but the damage amounts are uncertain.

a. Illustrate the effects of the contingent liabilities associated with the hazardous materials spill on the accounts and financial statements.
b. Prepare a note disclosure relating to this incident.

Explanation / Answer

For contingent liabilities, to report, it must be probable and reasonably estimatable. The $170,000 settlement with the employee shoudl be reported. The $410,000 EPA fine is probable and estimatable. Thus you should report those 2 but not the homeowner case. They should be reported in the financial statements and disclosed in the footnotes of the 10K/10Q. Contingent liabilities should increase by $580,000 Journal entry shoudl be Debit Loss due to Lawsuit expense $580,000 Credit Contingent Liability - Lawsuit $580,000

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