Several months ago, Northwest Cover Paint Company experienced ahazardous materia

Question

Several months ago, Northwest Cover Paint Company experienced ahazardous materials spill at one of its plants. As a result,the Environmental Protection Agency (EPA) fined the company$750,000. The company is contesting the fine. Inaddition, an employee is seeking $1,000,000 damages related to thespill. Last, a homeowner has sued the company for$200,000. The homeowner lives 25 miles from the plant, butbelieves that the incident has reduced the home’s resalevalue by $200,000.

Northwest Cover’s legal counsel believes that it isprobable that the EPA fine will stand. In addition, counselindicates that an out-of-court settlement of $300,000 has recentlybeen reached with the employee. The final papers will besigned next week. Counsel believes that the homeowner’scase is much weaker and will be decided in favor of NorthwestCover. Other litigation related to the spill is possible, butthe damage amounts are uncertain.

Explanation / Answer

Uncertain or potential obligations are contingent liabilities. Rules Probable and estimable - Record in the financial statements as aloss and a liability. Reasonably possible - Footnoted to the statements Remote - No required disclosure. In this case, classify all the transactions in the 3categories. Probable and estimable - 300,000 out-of-court settlement to theemployee Reasonably possible - EPA fine Remote - Home owner's case. So, 1.   Loss contingency on hazardous materialsspill         Dr     300,000                 Loss contingencypayable                                          300,000 2. EPA fine is shown as a footnote to the financialstatement.    Northwest has a contingency liability of $ 750,000arised as a penalty from Environmental Protection Agency and thefine is contested by the company. ( Make up couple more sentencesas you wish). 3.The Homeowners case is weak and hence no disclosure isrequired. Hope this may help you !

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