sng E3-2ZA(Learning objectives 1, S: Keport a contingent liahility)Smith Securit
ID: 2578994 • Letter: S
Question
sng E3-2ZA(Learning objectives 1, S: Keport a contingent liahility)Smith Security Systems' revenues for 2012 totaled $25.8 million. As with most companies, Smith is a defendant in lawsuits related to its products. Note 14 of the Smith Annual Report for 2012 reported the following 14. Contingencies The company is involved in various legal proceedings....It is the Company's policy to accrue for amounts related to these legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable. Suppose Smith's lawyers believe that a significant legal judgment against the company is reasonably possible. How should Smith report this situation in its financial statements? Suppose Smith's lawyers believe it is probable that a $3 million judgment will be rendered against the company. Report this situation in Smith's financial statements. Journalize any entry requirements by GAAP. Explanations are not required. 1. 2.Explanation / Answer
As we know that contingent liability are those liability which depends on some future events. So these will be liability or not depends on occurrence of a future event.
These contingency liabilities are divided into three categary for the purpose of recording;
1. Probable
2. Resonable
3. Remote
So now let’s see the question;
(1).
As it is given in the question that liability is resonable possible, so recording of liability in this conditon will be as follow;
No recording of expense in the income will be made.
Apart from this liability will not be recorded in the balance sheet because liability is resonable possible. Hence this liability will be disclosed in the notes to financial statements.
(2).
As it is given in the question that liability is probable, so recording of liability in this conditon will be as follow;
$3 million will be recorded as an expense / loss in the income statement.
$3 million will be recorded as liability in the Balance Sheet.
Following journal entry will be passed in the books;
Account Titles
Debit
Credit
Expenses or Loss
3 Million
Liability
3 Million
(For recording probable liability in the journal)
Account Titles
Debit
Credit
Expenses or Loss
3 Million
Liability
3 Million
(For recording probable liability in the journal)
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