Question

7.6 Accrual for a Lawsuit, Writing an Issues Memo

Your company has just been named as defendant in a lawsuit related to a food poisoning incident. The plaintiff is suing for $200,000 in damages; your company believes the ultimate amount of loss could range between $25,000 and $175,000, with no amount in the range more likely than other amounts in the range. The lawsuit is expected to be resolved in the second quarter of next year.

Citing from authoritative literature, prepare a brief accounting issues memo to the files addressing (1) whether a loss should be accrued, and for what amount, and (2) what disclosures should be made in the company’s financial statements.

Answer 1

HI Here we go

1. Yes accrual should be booked. Once the lawsuit is resolved based on that we need to adjust or reverse the journal. Contingent liability is recorded in the accounting records if the contingency is likely and the amount of the liability can be reasonably estimated.

Lawsuit Loss A/c Dr $200000

To Lawsuit Liability A/c Cr $200000

2. The liability may be disclosed in a footnote on the financial statements.

If a contingent liability is deemed probable, it must be directly reported in the financial statements. Nevertheless, generally accepted accounting principles, or GAAP, only require contingencies be recorded as unspecified expenses.