[nalratoss]

On November 25, Year 4, an explosion occurred at a Rex Co. plant causing extensive property damage to area buildings. By March 10, Year 5, claims had been asserted against Rex. Rex’s management and counsel concluded that it is probable Rex will be responsible for damages, and that $3.5 million would be a reasonable estimate of its liability. Rex’s $10 million comprehensive public liability policy has a $500,000 deductible clause. Rex’s December 31, Year 4, financial statements, issued on March 25, Year 5, should report this item as

An accrued liability of $500,000.
A disclosure in the notes to the financial statements indicating the probable loss of $3.5 million.
A disclosure in the notes to the financial statements indicating the probable loss of $500,000.
An accrued liability of $3.5 million.

Why isn’t the answer an accrued liability of 3.5 million? It already reasonably estimated the liability to be 3.5 million? What does the 500,000 deductible clause has to do with contingency??

[Anonymous]

The way insurance works is you are responsible for the deductible and the insurance covers damages in excess of the deductible.

The point of insurance is to cover you against risk of loss, so Rex would not pay the 3.5million. The insurance company would. All Rex would pay is the $500,000 deductible. You car insurance works in the exact same manner.
Since the contingency is probable and a known amount it has to be accrued,as it happpened before the balance sheet date. It also has to be disclosed in the notes.

Hope that helps. Cheers!

[jessanqi]

hi, is this answer A or c? I'm not sure if we just disclosure or need accrue also??

Please help!!

[Author]

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