Unit 1: may 2011, Question #3(d)

Contingency Liabilities and Contingency Assets.

1.  The lawsuit brought against Montego Company by the factory worker is a possible contingent liability and should be disclosed in the notes to the financial statements. A provision for the contingent liability should not be made as it is only possible not probable, the range of the possible settlement should also be disclosed in the notes.
2. Montego Company should create a  provision for the suit filed by the supplier as it is probable that the company will have to make payments in this regard. Montego Company also has a reliable estimate of the probable loss and there is a present obligation in the form of a contract, therefore a provision of $600,000 ($350,000+$250,000) should be created. This is done by debiting the Income Statement and crediting the provision for the liability with $600,000. Additionally, Montego Company should disclose the nature of the liability, the amount of the suit and the range of the possible loss.
3. The anticipated gain related to the case with Peete Company should not be recorded, as a contingent gain should only be recorded when it has been realized. The contingent gain may be disclosed in the notes to the financial statement if Montego Company has determined that the probability of it being realized, is extremely high.

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