Can some one tell why we recognize liability of $500000 why not $3500000. Since gain from Insurance policy we can recognize now, so….
On November 25, 2005, an explosion occurred at a Rex Co. plant, causing extensive property damage to area buildings.
By March 10, 2006, claims had been asserted against Rex. Rex's management and counsel concluded that it is probable Rex will be responsible for damages, and that $3,500,000 would be a reasonable estimate of its liability. Rex's $10,000,000 comprehensive public liability policy has a $500,000 deductible clause.
Rex's December 31, 2005, financial statements, issued on March 25, 2006, should report this item as:
A. A footnote disclosure indicating the probable loss of $3,500,000.
B. An accrued liability of $3,500,000.
C. An accrued liability of $500,000.
D. A footnote disclosure indicating the probable loss of $500,000.
You Answered Incorrectly.
Contingent liabilities that are probable and estimable, like this one, must be recognized in the accounts. The $500,000 deductible is the amount that will probably have to be paid. The $3,500,000 amount overstates the amount the firm will have to pay. This answer has the correct reporting option, but the wrong amount.
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