Question

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. 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 $111 million plus interest, a total of $126 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 $144 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 $204 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 $110 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 $37 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

Eastern Manufacturing can deal with the situations in the following ways -:

1. This is a loss contingency. In this case as the outcome is uncertain and judgement will be appealed therefore there is no need to accrue $126 million loss. A disclosure note is appropriate. No journal entry is required for the same.
2. This is a loss contingency. In this case it is probable that $144 million will be required to cover the cost of violations. Therefore, Eastern should accrue $144 million loss. Entry for the same will be-

Loss- Litigation A/c         Dr.	$144,000,000
Liability- Litigation a/c		$144,000,000.00

3. This is a gain contingency. Gain Contingency are not accrued even if gain is probable and can be reliably estimated. However, it will be disclosed in notes to the financial statements. Therefore, no journal entry is required for the same.
4. No disclosure is required in this case because the competitor has not yet file a law suit. The claim here is unasserted. Therefore, no journal entry is required for the same.