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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Contingencies Fallon Company, a toy manufacturer that also operates several retail outlets, is preparing its December 31, 2019, financial statements. It has identified the following legal situations that may qualify as contingencies:

A customer is suing the company for $800,000 in damages because her child was injured in November 2019 while riding an escalator that stopped suddenly in one of its stores. The child was hurt when he tripped and fell while walking “down” an escalator that was going “up.” Legal counsel feels that the child is partially at fault, but that it is probable that the lawsuit will be settled for between $ SO,000 and $100,000, with $80,000 being the most likely amount.

Fallon has discovered that a skateboard it began manufacturing and selling in 2019 has defective bearings, sometimes causing a wheel to fall off. Fallon has issued a “recall” notice in newspapers and magazines in which it offers to replace the bearings. It estimates a cost of $200,000 for these repairs. No lawsuits have been filed for injury claims, although the company feels that there is a reasonable possibility that claims may total as high as $2 million.

Fallon has an incinerator behind one of its retail outlets which is used to burn cardboard boxes received in shipments of inventory from suppliers. The state environmental protection agency filed suit against the company in August 2019 for air pollution. Fallon expects to stop using the incinerator and begin recycling. However, its lawyers believe that it is probable that a fine of between $40,000 and $60,000 will be levied against the company, although they cannot predict the exact amount.

In early 2019, Fallon signed a contract with a computer vendor to install “state of the art” cash registers in all of its retail outlets. Because of the vendor’s inability to acquire sufficient cash registers, the vendor canceled the contract. Fallon has filed a breach of contract suit against the vendor, claiming $300,000 in damages. The company’s lawyers expect that it will settle the suit “out of court” for $150,000.

Required:

Next Level For each situation, prepare the journal entry (if any) on December 31, 2019, to record the information for Fallon, and explain your reasoning. If no journal entry is recorded, explain how the information would be disclosed in Fallon’s 2019 annual report.

How would your answers change if Fallon used IFRS?

1.

To determine

Prepare the journal entry in the books of Company F as on December 31, 2019.

Explanation

Situation 1: In this, a customer of Company F has filed a suit for $800,000. The legal counsel enquired about the case and estimated the loss and they finalized that the suit can be settled between $50,000 and $100,000, and $80,000 is being the most likely amount. Thus, $80,000 would be reported as the loss for Company F. The journal entry is as follows:

DateAccount Titles and ExplanationsDebit ($)Credit ($)
December 31, 2019Loss from litigation80,000 
     Estimated liability from lawsuit 80,000
 (To recognize the loss from litigation)  

Table (1)

  • Loss from litigation is recognized. Thus, debit loss from litigation with $80,000.
  • Estimated liability from lawsuit is a liability and it is increased. Thus, credit estimated liability from lawsuit with $80,000.

Situation 2: In this the loss is probable in nature, as the Company F itself has published a recall notice and the estimated cost of it $200,000 for repairs. Thus, the loss must be accrued as the conditions are met. The journal entry is as follows:

DateAccount Titles and ExplanationsDebit ($)Credit ($)
December 31, 2019Repair and maintenance expense200,000 
     Estimated liability for recall     repairs 200,000
 (To recognize the expense and liability)  

Table (2)

  • Repairs and maintenance expense is an expense account and it decreases the value of shareholders’ equity...

2.

To determine

Explain the changes in the answers, if Company F uses IFRS.

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