Question

On December 31, Year 4, Mith Co. was a defendant in a pending lawsuit. The suit arose from the alleged defect of a product that Mith sold in Year 1. In the opinion of Mith’s attorney, it is probable that Mith will have to pay $50,000, and it is reasonably possible that Mith will have to pay $60,000 as a result of this lawsuit. In its Year 4 financial statements, Mith should report _________.A. An accrued liability of $50,000 only.
B. No information about this lawsuit.
C. An accrued liability of $50,000 and would disclose a contingent liability for an additional $10,000.
D. An accrued liability of $60,000 only.

Answer 1

Answer:

C) An accrued liability of $50,000 and would disclose a contingent liability for an additional $10,000.

Explanation:

Since it is probable that Mith will lose the case, hen it must report an accrued liability of $50,000 which represent the most likely outcome of the lawsuit. But since it is also possible that they have to pay $10,000 more, they should report that amount as contingent liability.

Contingent liabilities are those events that can result in a loss and have more than 50% chance of occurring. Since it is not certain that it will happen, they are considered contingent (or just in case).

Since the first $50,000 are probable, they must be recorded as accrued liabilities, since the last $10,000 are possible, they must be recorded as contingent liabilities.