Question

On January 15, 2020, Bob Falls slipped on the ice outside of Big Box Department Store. Bob maintains that he was hurt during the Fall, and that he incurred medical and other financial problems as a result. Outside cameras recorded the accident, and clearly show Bob falling and hitting his head.
Accordingly, Bob has decided to sue Big Box Department Store for damages. The judge has indicated that if the parties do not settle, they case will be heard in court on March 31, 2021. Big Box Department Store'slegal advisers have informed Big Box that they believe if the case goes to trial, there is a 10% chance the court will rule in favor of Big Box and they will pay no damages, there is 70% chance that the court will find BigBox negligent and Big Box will have to pay $ 1,000,000 in damages, and there is a 20% chance the court will rule in favor of Bob Falls and will rule that Big Box has to pay $ 5,000,000 in damages.
Assuming that any probability greater than 85% is considered ." probable", what liability, if any, should Big Box Department Store report on their December 31, 2020 Balance Sheet if they decide to take the case tocourt and also want to remain in compliance with US GAAP?

A.$0

B.$ 1,000,000

C.$ 1,700,000

D.$ 5,000,000

Answer 1

Correct asnwer is C) $1,700,000

As per the US GAAP liability is recorded if it is probable and can be reasonabally estimated.

In the given situation if probability is greater tha 85% it is probable.So as per the legal advisor's there is 70% chance that Big box will have to pay $1,000,000 and 20% chance that it will. have to pay $5,000,000.So the total probability of Big box paying is 90% (70+20), which is greater than 85% and hence liability is probable and must be recorded.

Amount of liability recorded=$1,000,000*70%+$5,000,000*20%

=$700,000+$1,000,000

Total amount of liability recorded=$1,700,000