Determine the appropriate means of reporting each situation.
In a memo to the audit manager, Mitch Riley, explain your reasoning. Include any necessary journal entries and drafts of appropriate disclosure notes.
In the March 2014 meeting of Valleck Corporation’s board of directors, a question arose as to the way a possible obligation should be disclosed in the forthcoming financial statements for the year ended December 31. A veteran board member brought to the meeting a draft of a disclosure note that had been prepared by the controller’s office for inclusion in the annual report.
Here is the note:
On May 9, 2013, the United States Environmental Protection Agency (EPA) issued a Notice of Violation (NOV) to Valleck alleging violations of the Clean Air Act. Subsequently, in June 2013 the EPA commenced a civil action with respect to the foregoing violation seeking civil penalties of approximately $853,000. The EPA alleges that Valleck exceeded applicable volatile organic substance emission limits. The Company estimates that the cost to achieve compliance will be $190,000; in addition, the Company expects to settle the EPA lawsuit for a civil penalty of $205,000 which will be paid in 2014.
“Where did we get the $205,000 figure?” he asked. On being informed that this is the amount negotiated last month by company attorneys with the EPA, the director inquires, “Aren’t we supposed to report a liability for that in addition to the note?
Explain whether Valleck should report a liability in addition to the note. Why or why not? For full disclosure should anything be added to the disclosure note itself?