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Contingencies: Estimating the Liability to Report for Contingencies.

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13. (Contingencies) Presented below are three independent situations. Answer the question at the end of each situation.

1. During 2004, Salt-n-Pepa Inc. became involved in a tax dispute with the IRS.
Salt-n-Pepa's attorneys have indicated that they believe it is probable that Salt-n-Pepa will lose this dispute. They also believe that Salt-n-Pepa will have to pay the IRS between $900,000 and $1,400,000. After the 2004 financial statements
were issued, the case was settled with the IRS for $1,200,000. What amount, if any, should be reported as a liability for this contingency as of December 31, 2004?

2. On October 1, 2004, Alan Jackson Chemical was identified as a potentially responsible party by the Environmental Protection Agency. Jackson's management along with its counsel have concluded that it is probable that Jackson will be
responsible for damages, and a reasonable estimate of these damages is $5,000,000. Jackson's insurance policy of $9,000,000 has a deductible clause of $500,000. How should Alan Jackson Chemical report this information in its financial statements at December 31, 2004?

3. Melissa Etheridge Inc. had a manufacturing plant in Bosnia, which was destroyed in the civil war. It is not certain who will compensate Etheridge for this destruction, but Etheridge has been assured by governmental officials that it will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant, but more than its book value. How should the contingency be reported in the financial statements of Etheridge Inc.?

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Solution Preview

Question 1: According to FASB requirements, the amount is accrued only when some amount within the range appears at the time to be a better estimate than any other amount within the range. The amount at the low end of the range is accrued when no amount within the range is a better ...

Solution Summary

The problem discusses the three different situations on contingencies and what is the correct approach to deal with these situations. The solution refers to the FASB and other guidelines to estimate the reported liability for the contingency. 204 words.

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Current Liability, Contingencies, Asset Retirement Obligation and Premiums

Contingencies

a). During 2012, Maverick Inc. became involved in a tax dispute with the IRS. Maverick's attorneys have indicated that they believe it is probable that Maverick will lose this dispute. They also believe that Maverick will have to pay the IRS between $800,000 and $1,400,000. After 2012 financial statements were issued, the case was settled with the IRS for $1,200,000. What amount, if any, should be reported as a liability for this contingency as of 12/31/12?

b). On 10/1/12, Holmgren Chemical was identified as a potentially responsible party by the Environmental Protection Agency. Holmgren's management along with its counsel have concluded that is probable that Holmgren will be responsible for damages, and a reasonable estimated of these damages is $6,000,000. Holmgren's insurance policy of $9,000,000 has a deductible clause of $500,000. How should Holmgren Chemical report this information in its financial statements at 12/31/12?

c). Shinobi Inc. had a manufacturing plant in Darfur, which was destroyed in the civil war. It is not certain who will compensate Shinobi for this destruction, but Shinobi has been assured by governmental officials that will receive a definite amount for this plant. The amount of the compensation will be less than the fair value of the plant but more than its book value. How should the contingency be reported in the financial statements of Shinobi Inc.?

Asset Retirement Obligation

Bassinger Company purchases an oil tanker depot in 1/1/12, at a cost of $600,000. Bassinger expects to operate the depot for 10 years, at which time it is legally required to dismantle the depot and remove the underground storage tanks. It is estimated that it will cost $70,000 to dismantle the depot and remove the tanks at the of the depot's useful life.

a). Prepare the journal entries to record the depot (considered a plant asset) and the asset retirement obligation for the depot on 1/1/12. Based on an effective-interest rate of 6%, the fair value of the asset retirement obligation on 1/1/12, is $39,087.

b). Prepare the journal entries required for the depot and asset retirement obligation at 12/31/12. Bassinger uses straight-lime depreciation; the estimated residual value for the depot is 0.

c). On 12/31/12. Bassinger pays a demolition firm to dismantle the depot and remove the tanks at a price of $80,000. Prepare the journal entry for the settlement of the asset retirement obligation.

Premiums

1. Marquart Stamp Company records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Marquart's past experience indicates that only 80% of the stamps sold to licensees will be redeemed. Marquart's liability for stamp redemptions was $13,000,000 at December 31, 2009. Additional information for 2010 is as follows:

-Stamp service revenue from stamps sold to licenses $9,500,000
-Cost of redemptions (stamps sold prior to 1/1/12) $6,000,000

If all the stamps sold in 2010 were presented for redemption in 2011, the redemption cost would be $5,200,000. What amount should Marquart report as a liability for stamp redemptions at December 31, 2010?

2. In packages of its products, Wiseman Inc. includes coupons that may be presented at retail stores to obtain discounts on other Wiseman products. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Wiseman honors requests for coupon redemption by retailers up to 3 months after the consumer expiration date. Wiseman estimates that 60% of all coupons issued will ultimately be redeemed. Information relating to coupons issued by Wiseman during 2010 is as follows:
-Consumer expiration date 12/31/12
-Total face amount of coupons issued $850,000
-Total payments to retailers as of 12/31/12 330,000
What amount should Wiseman report as a liability for unredeemed coupons at December 31, 2010?

3. Newell Company sold 600,000 boxes of pie mix under a new sales promotional program. Each box contains one coupon, which submitted with $4.00, entitles the customer to a baking pan. Newell pays $6.00 per pan and $0.50 for handling and shipping. Newell estimates that 70% of the coupons will be redeemed, even though only 250,000 coupons had been processed during 2010. What amount should Newell report as a liability for unredeemed coupons at December 31, 2010?

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