EX 10-21 Contingent liabilities Several months ago, Ayers Industries Inc. experi

Question

EX 10-21 Contingent liabilities Several months ago, Ayers Industries Inc. experienced a hazardous materials spill at one of its plants. As a result, the Environmental Protection Agency (EPA) fined the company $240,000. The company is contesting the fine. In addition, an employee is seeking $220,000 in damages related to the spill. Lastly, a homeowner has sued the company for $310,000. The homeowner lives 35 miles from the plant but believes that the incident has reduced the home's resale value by $310,000. OBJ.5 Ayers' legal counsel believes that it is probable that the EPA fine will stand. In ad- dition, counsel indicates that an out-of-court settlement of $125,000 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 Ayers. Other litigation related to the spill is possible, but the damage amounts are uncertain. a. Journalize the contingent liabilities associated with the hazardous materials spill. Use the account "Damage Awards and Fines" to recognize the expense for the period. b. Prepare a note disclosure relating to this incident.

Explanation / Answer

For your understanding, GAAP on contingent liability explain three three types Contingent loss Type of loss Accounting treatment 1 Probable Provision should be made by way of passing journal entry 2 Reasonably Possible Possible disclosure is made in the accounts by way of Note 3 Remote It should be ignored Date/S.N. Account title & Explanation Debit Credit Amount in $ Amount in $ Damage Awards & Fines 240000 Enviornment Protection Agency 240000 To record the entry for acknowledgement of probable loss Damage Awards & Fines 125000 An Employee 125000 To record the entry for acknowledgement of probable loss        Litigation in the case of Homeowner's is most likely to be decided in favour of Ayers. So, This is considered as remote contingent loss and it may ignored altogether. Notes to be given in the financial statement "Several Month's ago, Company experienced the hazardous materials spill at one of its plants. All probable contingent losses relating to spill is recognised as the expenses for the period. However, other litigation related to spill is reasonably possible, but the damage amount are uncertain.

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