Question

In the March 2022 meeting of Valleck Corporation's board of directors, a question arose as to the way a possible obligation should be disclosed in the forthcoming financial statements for the year ended December 31. A veteran board member brought to the meeting a draft of a disclosure note that had been prepared by the controller's office for inclusion in the annual report. Here is the note: On May 9, 2021, the United States Environmental Protection Agency (EPA) issued a Notice of Violation (NOV) to Valleck alleging violations of the Clean Air Act. Subsequently, in June 2021, the EPA commenced a civil action with respect to the foregoing violation seeking civil penalties of approximately $853,000. The EPA alleges that Valleck exceeded applicable volatile organic substance emission limits. The Company estimates that the cost to achieve compliance will be $190,000; in addition the Company expects to settle the EPA lawsuit for a civil penalty of $205,000 which will be paid in 2022. "Where did we get the $205,000 figure?" he asked. On being informed that this is the amount negotiated last month by company attorneys with the EPA, the director inquires, "Aren't we supposed to report a liability for that in addition to the note?" Required: Should Volleck report a liability in addition to the note, and should anything be added to the disclosure note itself? Valleck should accrue the $190,000 compliance cost and disclose the $205,000 penalty. O Valleck should accrue both the $190,000 compliance cost and the $205,000 penalty. Volleck should disclose but not accrue both the $190,000 compliance cost and the $205,000 penalty.

Answer 1

Answer is (a) Valley should accrue $190000 compliance cost and disclose $205000 as penalty.

Penalty is disclosed as contingent liability. Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event and includes the outcome of a pending lawsuit.