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Journal Entries for Lawsuit Settlements

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- Baron Company is facing several contingencies related to potential environmental violations, lawsuits, and assessments. - The city government is investigating potential chemical leaks at …

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  • Problem 4-9 (IAA)
  • Problem 4-8 (IAA)

Problem 4-9 (IAA)

Baron Company is involved with several situations about contingencies. The fiscal year
ends December 31, 2020 and
financial statements are issued on March 1, 2021.
On March 1, 2021, the city government is in the process of investigating possible
chemical leaks at Baron s facilities but has not proposed a deficiency assessment.
Management feels an assessment is reasonably possible and if an assessment is made
an unfavorable settlement of up to P4,000,000 is reasonably possible.
Baron is the plaintiff in a P3,000,000 lawsuit filed against Faye Company for damages
due to lost profit from rejected contracts and for unpaid receivables.
The case is in final appeal and legal counsel advised that it is probable that Baron will
prevail and be awarded P2,500,000

In July 2020, the provincial government filed suit against Baron seeking civil penalties
and injunctive relief for violation of environmental law regulating hazardous waste. On
February 15, 2021, Baron reached a settlement with state authorities.

Based upon discussions with legal counsel, Baron feels it is probable that P2,000,000
will be required to cover the cost of violation.

Baron believed that the ultimate settlement of this claim will not have a material adverse
effect on the entity. Baron is involved in a lawsuit resulting from a dispute with a
customer. On January 5, 2021, judgment was rendered against Baron in the amount of
P1,500,000 plus interest of P300,000.

Baron plans to appeal the judgment and is unable to predict its outcome though it is not
expected to have a material adverse effect on the entity.

Required:

Prepare any necessary journal entries to recognize the situations involving


contingencies.
e on one of the facilities related to the division. It is estimated that it will have to or a
penalty of P4,000,000 to break the lease.
The entity estimates that the present value related to payment on the lease contract is
P6,500,000.
The entity's allocation of overhead costs to other divisions will increase by P15,000,000
due to the restructuring of the facilities.
Also, some employees will be shifted to other divisions within the entity and cost of
retraining the employees is estimated at P20,000,000
The entity has hired an outplacement firm to help in dealing with the number of
terminations related to the restructuring. It is estimated that the cost to the entity will be
P6,000,000.
Employee termination costs are estimated to be P30,000,000 and the entity believes
that moving usable assets from the toy division to other division within the entity will cost
P3,200,000.

Required:
Compute the total amount that should be included in restructuring provision.

Problem 4-8 (IAA) .


Western Company pro transactions related to contingencies
The fiscal year ends December 31, 2020: Financial Statement are issued on April 1,
2021.

 No customer accounts have been shown + uncollectible as yet but Western


estimated that 304 credit sales will eventually prove uncollectible. Cre sales
amounted P30,000,000 for 2020.

 Western offers a one-year warranty against manufacturer's defects for all its
products. Industries experience indicates that warranty costs will approximate 2%
of credit sales.

Actual warranty expenditures totaled P355,000 in 2020 and were recorded as


warranty expense when incurred.

 In December 2020, Western became aware of an engineering flaw in a product


that poses a potential risk of injury. As a result, a product recall appears
inevitable. This move would likely cost the entity P1,500,000.

 In November 2020, the City of Manila filed suit against Western asking civil
penalties and injunctive relief for violations of clean water laws.

Western reached a settlement with the city government authorities to pay


P4,200,000 in penalties on February 15, 2021.

 Western is the plaintiff in a P4.000.000 lawsuit filed against a customer for costs
and lost profit from contracts rejected in 2020.

The lawsuit is in final appeal and attorneys advised that it is probable that
Western will be awarded P3,000,000

Required: Prepare the appropriate journal entries that should recorded as a result of
each of these contingencies. If no journal entry is indicated, state the reason why.

Common questions

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Western Company should create a provision for doubtful accounts. The entry would be a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts based on the estimation for uncollectible credit sales from the total credit sales of P30,000,000. The estimation details are not quantified, so the exact entry depends on further calculation based on their estimation method .

Baron Company should record a loss for the judgment amount of P1,500,000 plus interest of P300,000. Though Baron plans to appeal the judgment, it is not expected to have a material adverse effect on the entity, but the total potential liability should be recognized as a contingent liability until the appeal's outcome is known .

Western Company should recognize the award from the lawsuit as a contingent gain only if the award is probable and the amount can be reliably measured. In the case presented, it is likely that Western will be awarded P3,000,000, which could be recognized as revenue once the final appeal confirms the decision .

Western Company should recognize warranty expense at 2% of the credit sales, totaling P600,000 (2% of P30,000,000). It should establish a warranty liability for any potential future expenditures as warranty expenses are expected based on historical data. However, actual expenditures in 2020 were P355,000 .

Western Company should establish a liability of P1,500,000 expected cost of the imminent product recall. As Western became aware of the issue in December 2020, this contingency should be accounted for the financial impact it represents on the entity's financial statements .

Baron Company should recognize a liability of P2,000,000 for the probable settlement of the environmental lawsuit in its financial statements. This is because the settlement has been agreed upon with state authorities and legal counsel advises that it is probable .

Baron Company manages its estimated liabilities by recognizing the restructuring provision for expected costs relating to employee termination, asset relocation, and division restructuring. Improving this process may involve regular assessments of cost estimates against actual expenses and incorporating flexible strategies that account for variations in restructuring progress and outcomes .

Baron Company should recognize a gain of P2,500,000 only if it is assured that the lawsuit will result in a favorable outcome, as advised by legal counsel. Given that the case is in final appeal and it is probable that Baron will prevail, this would be recognized as other income in the financial statements .

Baron Company should recognize a restructuring provision totaling the sum of employee termination costs (P30,000,000), retraining costs (P20,000,000), outplacement services (P6,000,000), and moving costs (P3,200,000). These estimated costs are necessary due to the restructuring and should be recognized as liabilities .

Western Company should recognize a liability for the P4,200,000 settlement reached with the city government for violations of clean water laws. This liability reflects the agreed penalties, which should have been recognized by February 15, 2021 .

Problem 4-9 (IAA) Baron Company is involved with several situations about contingencies. The fiscal year ends December 31,
Employee termination costs are estimated to be P30,000,000 and the entity believes that moving usable assets from the toy di

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