Question

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 $540,000. The company is contesting the fine. In addition, an employee is seeking $490,000 in damages related to the spill. Finally, a homeowner has sued the company for $340,000. The homeowner lives 30 miles from the plant but believes that the incident has reduced the home's resale value by $340,000. Ayers’ legal counsel believes that it is probable that the EPA fine will stand. In addition, counsel indicates that an out-of-court settlement of $210,000 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. If an amount box does not require an entry, leave it blank.

b. The note disclosure would a statement that the EPA fine is probable and would a statement about the homeowner lawsuit.

Answer 1

Contingent liabilities are the liabilities that may become payable depending on the outcome of an uncertain future event.

Example - Possible outcome of a pending lawsuit.

If the contingent liabilities are estimable and are probable, it must be recorded and disclosed in the financial statements.

a. As it is probable that the EPA fine will stand ie $540,000 and out of court settlement with the employee stands $210,000. These two liabilities will be recorded as.

Damage Awards and Fines	$750,000
Fines Payable	$750,000

b. A loss contingency is expected due to hazardous materials spill at one of our plants for which Environment protection agency(EPA) has fined the company $540,000 which stands probable.

A homeowner who stays 30 miles aways has also sued the company for $340,000, saying the incident decreased the value of his house by $340,000 but our council believes that his case seems weak and the case will turn in the favour of the company. Therefore this amount is excluded from the contingency reported.