Eastern Chemical Company is involved with several situations that could lead to contingencies. Each is described below.
a. During 2017, Eastern became involved in a tax dispute with the IRS. Eastern’s attorneys have indicated that they believe it is probable that Eastern will lose this dispute. They also believe that Eastern will have to pay the IRS between $900,000 and $1,400,000. After the 2017 financial statements were issued, the case was settled with the IRS for $1,200,000.
b. On October 1, 2017, Eastern was identified as a potentially responsible party by the Environmental Protection Agency. Eastern’s management along with its counsel have concluded that it is probable that Eastern will be responsible for damages, and a reasonable estimate of these damages is $5,000,000. Eastern’s insurance policy of $9,000,000 has a deductible clause of $500,000.
c. Eastern had a manufacturing plant in Egypt, which was destroyed during the recent Arab uprising. It is not certain who will compensate Eastern for this destruction, but Eastern has been assured by governmental officials that it will receive a definite amount for this plant.
List The amount of the compensation will be less than the fair value of the plant, but more than its book value. Required
1. For each of the three situations, how should the contingency be reported in the financial statements of Eastern?
2. Prepare any necessary journal entries and disclosure notes.