Eastern Manufacturing is involved with several situations that possibly involve

Question

Eastern Manufacturing is involved with several situations that possibly involve contingencies. Each is described below. Eastern’s fiscal year ends December 31, and the 2016 financial statements are issued on March 15, 2017.

Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2017, judgment was rendered against Eastern in the amount of $107 million plus interest, a total of $122 million. Eastern plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company.

In November 2015, the State of Nevada filed suit against Eastern, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2017, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $140 million will be required to cover the cost of violations. Eastern believes that the ultimate settlement of this claim will not have a material adverse effect on the company.

Eastern is the plaintiff in a $200 million lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Eastern will prevail and be awarded $100 million.

At March 15, 2017, Eastern knows a competitor has threatened litigation due to patent infringement. The competitor has not yet filed a lawsuit. Management believes a lawsuit is reasonably possible, and if a lawsuit is filed, management believes damages of up to $33 million are reasonably possible.

Prepare the appropriate journal entries for these situations.

1. Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2017, judgment was rendered against Eastern in the amount of $107 million plus interest, a total of $122 million. Eastern plans to appeal the judgment and is unable to predict its outcome though it is not expected to have a material adverse effect on the company.

2. In November 2015, the State of Nevada filed suit against Eastern, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On January 12, 2017, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $140 million will be required to cover the cost of violations. Eastern believes that the ultimate settlement of this claim will not have a material adverse effect on the company.

3. Eastern is the plaintiff in a $200 million lawsuit filed against United Steel for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Eastern will prevail and be awarded $100 million.

4. At March 15, 2017, Eastern knows a competitor has threatened litigation due to patent infringement. The competitor has not yet filed a lawsuit. Management believes a lawsuit is reasonably possible, and if a lawsuit is filed, management believes damages of up to $33 million are reasonably possible.

2-b

Indicate whether disclosure notes are required in each case

1.

2.

3.

4.

Eastern Manufacturing is involved with several situations that possibly involve contingencies. Each is described below. Eastern’s fiscal year ends December 31, and the 2016 financial statements are issued on March 15, 2017.

Explanation / Answer

Answer:

Situation# 1

Solution: This represents a loss contigency.Based on the information, eastern is unable to predict the outcome of the appeal.In addition, the outcome is not expected to have a material adverse effect on the company.Therefore, Eastern would not record $122 million loss.It would however provide a disclosure note.

Situation # 2

Solution: This is a loss contingency. Because it is probable that Eastern would have to pay $140 million, which can be reasonably estimated, Eastern should record the loss and related liability, and provide a footnote disclosures that details the nature of litigations and the loss.

Litigation loss Dr. 140000000

To litigation liabilitiy................140000000

Situation #3

Solution: This is a gain contingency.Gain contingencies are not accrued even if the gain is probable and reasonably estimable.The gain should be recognized only when realized. though gain contingencies are not recorded in the accounts, they should be in notes to the financial statements.

Situation #4

Solution: There would be no disclosure in this case because the EPA has not yet proposed a penalty assessment and the assessment is not probable.

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