Question

5 Eastern Manufacturing is involved with several situations that possibly involve contingencies. Each is described below. Eastern's fiscal year ends December 31, and the 2021 financial statements are issued on March 15, 2022. 16.66 points eBook Print References a. Eastern is involved in a lawsuit resulting from a dispute with a supplier. On February 3, 2022, judgment was rendered against Eastern in the amount of $109 million plus interest, a total of $124 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. b. In November 2020, 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, 2022, Eastern reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $142 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. c. Eastern is the plaintiff in a $202 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. d. At March 15, 2022, 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 $35 million are reasonably possible. Required: 1. Determine the appropriate way to report each situation. 2. Prepare the appropriate journal entries for these situations.

Answer 1

The correct answers are:

Part 1

a. Disclosure is required

b. Disclosure and accrual both are appropriate

c. Disclosure is required

d. Disclosure and accrual both are not needed

Part 2

a. No journal entry is needed

b. Journal entry to be booked will be:

Description Debit ($ millions) Debit ($ millions) Loss on Litigations 142 Litigation liability $ 142 $

c.No journal entry is needed

d.No journal entry is needed

Workings

a) Since the liability cannot be reasobaly estimated, it will be appropriate to not accrue the same but disclose the information in the notes to accounts.

b) Since the liability is certain and can be estimated, the company should accrue the liabillity in its financial statements.

c) Contingent gains are not accounted for in financial statements.

d) The liability is possible but since the same has not been filed, the management is not required to disclose the same in their financial statements

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