Question

Decorative Concrete produces a concrete overlay for residential and commercial concrete flooring. Customers have complained that one of the products results in excessive cracking. The likelihood the company will incur a loss on this product is probable and the amount of the loss is estimated to be somewhere between $1.1 and $4 million.
1. Should this contingent liability be reported, disclosed in a note only, or both? To be reported To be disclosed Both2. What loss, if any, should Decorative Concrete report in its income statement?3. What liability, if any should Decorative Concrete report in its balance sheet?4. What entry, if any should be recorded in the journal?

Answer 1

Answer:

Decorative Concrete

1. This contingent liability should be disclosed in a note only.

2. Decorative Concrete should not report any loss in its income statement, yet.

3. Decorative Concrete should not report any liability in its balance sheet, yet.

4. No entry should be recorded in the journal.

Explanation:

a) Data and Calculations:

Estimated loss = $1.1 and $4 million

Loss is probable but the loss cannot be reasonably estimated

b) Decorative Concrete cannot reasonably estimate the loss that may arise from the contingent liability.  Therefore, it should only disclose the future event in a note to the financial statements.  Accounting rules specify that Decorative Concrete should record this event as a contingent liability in its accounts when it is probable that the future event will occur and the amount of the liability can be reasonably estimated. At that time, a specific amount of loss will be recorded (debit) and a specific liability established (credit) in advance of the settlement.  In this Decorative's case, only one condition is met.