Monday, November 9, 2009

Liabilities and Legal Contingencies

In late November 2011, as accountants are closing the books for the fiscal year, they note several outstanding legal issues that the company has not resolved.

One issue is an FDA pending fine related to problems with a new product.

A second item involves an EEOC wrongful discharge case by a former employee.

Lastly, a current employee has filed suit against the company for compensatory damages for a work-related injury. The employee is seeking damages on the order of $2,500,000.

What the lawyer thinks:

The company's lawyer suggests that the fine may total $5,500,000 but will not be settled within the next year.

The lawyer  not think the wrongful discharge case will pass summary judgment, in which the former employee is suing for $1,500,000.

Lastly, The case involving the current employee will be settled for $500,000 in the next year.

Accounting Question: What are the journal entries that the company should recognize for the year?

Accounting Answer:

Two of the items are contingent and the third may be accrued as current year expenses.

Even if each case may be decided in the companies favor the item is contingent, this is what a contingent liability means and full provision should be made for the claims

There must be accounting journal entries for an expense of $5,500,000 and contingent liabilities of $4,000,000. This is the conservative approach required by accounting standards and will ensure that the company is able to meet its obligations.

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