Contingent Liability “Becker CPA Review FAR”

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    Dear Gentlemen,

    Please help i get confused about the following two questions :-

    1- FAR 5 – Model 2 – Example 1

    Alton Company is the defendant in a wrongful death suit filed as the result of the
    death of an employee who was working on one of the company's production lines. The
    plaintiff filed Suit in June and has asked for damages Of $3.000.00(). Alton carries insurance
    for potential claims of this nature. but the insurance coverage amounts to $1500.000.
    Legal counsel for Alton believes that the Judge will rule ‘n the plaintiffs favor and that the
    company will have to pay about $2,200,000. but the settlement could reach $3,000,000.
    Required: Identify the financial statement treatment for the contingency and prepare the
    journal entry.

    Alton should record the following entry at year-end

    DR: loss $2,200,000
    CR: liability $2,200,000

    It is probable that the judge will rule against Alton. Because estimate of the settlement
    is a range. the should be recorded as the contingency amount. with disclosures
    indicating the maximum settlement amount Of The insurance proceeds that
    may result would be treated as a gain contingency and not recorded until received.

    2- FAR 2 – Model 3 – MCQ-00916

    On January 17, Year 2, an explosion occurred at a Sims Co. plant causing extensive property
    damage to area buildings. Although no claims had yet been asserted against Sims by March
    10, Year 2, Sims' management and counsel concluded that it is likely that claims will be
    asserted and that it is reasonably possible Sims will be responsible for damages. Sims'
    management believed that $1,250,000 would be a reasonable estimate of its liability. Sims'
    $5,000,000 comprehensive public liability policy has a $250,000 deductible clause. In Sims'
    December 31, Year 1, financial statements, which were issued on March 25, Year 2, how
    should this item be reported?

    A. As an accrued liability of $250,000.
    B. As a footnote disclosure indicating the possible loss of $250,000.
    C. As a footnote disclosure indicating the possible loss of $1,250,000.
    D. No footnote disclosure or accrual is necessary.

    Choice “B” is correct. This is a non recognized subsequent event as it occurred after the
    December 31, Year 1 balance sheet date. Because there is a reasonably possible contingent
    loss of $250,000, footnote disclosure is required.
    Rule: Only footnote disclosure is required for a “reasonably possible” loss. The nature of the
    contingency should be disclosed as well as the nature of the possible loss or range of loss.
    Since insurance appears to be available for the entire loss except the deductible portion, only
    the possible loss of $250,000 needs to be included in the footnote.
    Note: Even though the explosion occurred (January 17, Year 2) after the date of the FS
    (December 31, Year 1) disclosure is still required since the statements had not yet been
    I get confused because…. regardless whether contingent is probable or possible my question is why in the Example 1 we didn't net the contingent amount with the insurance policy like we did in the MCQ-00916 !!!???

    Thanks and best regards appreciate your help guys.

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