Assignment Problem: Unrecorded liability
Scorpio Ltd has finally concluded its negotiations to acquire Norma Ltd, and has secured ownership of all the shares of Norma Ltd. One of the areas of discussion during the negotiation process was the current court case that Norma Ltd was involved in. The company was being sued by some former employees who were retrenched, but are now claiming damages for unfair dismissal. The company did not believe that it owed these employees anything. However, realizing that industrial relations was an uncertain area, particularly given the country's current confusing industrial relations laws, it had raised a note to the accounts issued before the takeover by Scorpio Ltd reporting the existence of the court case as a contingent liability. No monetary amount was disclosed, but the company's lawyers had placed a $56 700 amount on the probable payout to settle the case.
The accounting staff of Scorpio Ltd is unsure of the effect of this contingent liability on the accounting for the consolidated group after the acquisition. Some argue that it is not a liability of the group and so should not be recognized on consolidation, but are willing to accept some form of note disclosure. A further concern being raised is the effects on the accounts, depending on whether Norma Ltd wins or loses the case. If Norma Ltd wins the court case, it will not have to pay out any damages and could get reimbursement of its court costs, estimated to be around $40 000.
Required: Give your opinion on the treatment of the contingent liability at acquisition date for consolidation purposes, as well as any subsequent effects when Norma Ltd either wins or loses the case.
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