Question

(Loss Contingencies: Entries and Essays) Polska Corporation, in preparation of its December 31, 2017, financial statements, is attempting to determine the proper accounting treatment for each of the following situations.

1. As a result of uninsured accidents during the year, personal injury suits for \(350,000 and \)60,000 have been filed against the company. It is the judgment of Polska’s legal counsel that an unfavorable outcome is unlikely in the \(60,000 case but that an unfavorable verdict approximating \)250,000 will probably result in the \(350,000 case.

2. Polska owns a subsidiary in a foreign country that has a book value of \)5,725,000 and an estimated fair value of \(9,500,000. The foreign government has communicated to Polska its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Polska expects to receive 40% of the fair value of its properties as final settlement.

3. Polska’s chemical product division consisting of five plants is uninsurable because of the special risk of injury to employees and losses due to fire and explosion. The year 2017 is considered one of the safest (luckiest) in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of three casualties a year during the rest of the past decade (ranging from \)60,000 to $700,000), management is certain that next year the company will probably not be so fortunate.

Instructions

(a) Prepare the journal entries that should be recorded as of December 31, 2017, to recognize each of the situations above.

(b) Indicate what should be reported relative to each situation in the financial statements and accompanying notes. Explain why.

Short answer

(a) Journal entries are recorded in Step 1.

(b) (1) the lawsuit liability will be recorded as loss is probable and reasonably estimated. (2) The exportation loss is probable, and also the amount is reasonably estimated, hence the loss will be recorded. (3) The loss will not be recorded as there is no impairment loss and also loss amount is not reasonably estimated.

Step-by-step solution

(a) Journal entries

Transactions	Accounts & Explanations	Debit	Credit
(1)	Lawsuit Loss	$250,000
	Lawsuit Liability		$250,000
	(To record the contingent lawsuit liability)
(2)	Loss from Expropriation	$1,925,000
	Allowance for Expropriation		$1,925,000
	(To record loss from expropriation) ($5,725,000 – (40% x $9,500,000))
(3)	No entry

(b) Reporting of contingent losses

(1) In this case, the company has estimated the probable loss of $250,000 arising due to personal injury suits of passengers. Hence, in this case, $250,000 should be recorded as lawsuit liability as the loss is probable and also the amount can be estimated for the probable loss.

(2) In the given case, the company will record the loss arising due to expropriation. The company will record the loss from the expropriation of $1,925,000 which is calculated as the excess of 40% of the fair value of $9,500,000 over the book value of $5,725,000. 40% indicates the final settlement of the fair value that is expected to receive.

(3) The loss arising due to impairment of loss is not probable and also the loss arising due to impairment cannot be reasonably estimated, hence the loss will not be recorded.