Question

Contingent Liabilities Several months ago, Cinnabar Chemical Company experienced a hazardous materials spill at one of its plants. As a result, the Environmental Protection Agency (EPA) fined the company $1,471,500. The company is contesting the fine. In addition, an employee is seeking $471,500 damages related to injuries sustained while cleaning up the spill. Lastly, a homeowner has sued the company for $229,000. The homeowner lives 15 miles from the plant but believes that the incident has reduced the home's resale value by $229,000. Cinnabar'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 $259,325 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 Cinnabar. 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. If no account or activity is affected, select "No effect" from the dropdown list and leave the corresponding number entry box blank. Enter account decreases and cash outflows as negative amounts Balance Sheet Income Statement of Cash Flows Assets Liabilities + Stockholders' Equity Statement Statement of Cash Flows Income Statement b. If other litigation related to the spill is possible, but the damage amounts are uncertain, which of the following is the best course for Cinnabar to follow in its reporting? Ignore it since nothing is certain. Disclose the potential for litigation in a note disclosure. Accrue an estimate of the potential litigation amount and disclose the reasons that the company expects further litigation in a note disclosure. Disclose an estimated amount of a settlement that the company's attorney is authorized to offer.

Answer 1

Statement of Cash Flows Income Statement Balance Sheet Assets Liabilities Stockholder's Equity No Effect = EPA Fines Payable + Litigation Claims Payable + Retained earnings 1471500 + 259325 -1730825 Statement of Cash Flows No Effect Damage awards & Fines Expense Income Statement -1730825 28 b. If other litigation related to the spill is possible, but the damage amounts are uncertain, which of the following is the best course for Cinnabar to follow in its reporting? 29 Disclose the potential for litigation in a note disclosure 31