Question

The Environmental Protection Agency notifies Shevlin Company that a state where it has a plant is filing a lawsuit for groundwater pollution against Shevlin and another company that has a plant adjacent to Shevlin’s plant. Test results have not identified the exact source of the pollution. Shevlin’s manufacturing process often produces by-products that can pollute groundwater. Based on the above information, assume the loss is reasonably possible but the company cannot estimate the amount of potential obligations, what is the proper accounting treatment for Shevlin Company?

Select one:

A. Increase stockholder’s equity

B. None of the answers are correct.

C. Record a liability on the balance sheet

D. Disclose the liability in a footnote

Answer 1

Contingent liabilities:

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D. Disclose the liability in a footnote.

Explanation:

Contingent liabilities are potential liability which may result in actual liability to the business. This may depend on any future event and loss due to such liability may be subject to estimation. To recognize contingent liabilities in books of account, two conditions need to be fulfilled. If liability is probable and subject to reasonable estimation, it can be recognized in books of account. As in the present case, the loss is reasonably possible (Not Probable) and the same can not be estimated. In such a scenario, such loss can be disclosed as a liability in the footnote.