For the first quarter of 2017, prepare any needed correcting or adjusting journa
ID: 2573953 • Letter: F
Question
For the first quarter of 2017, prepare any needed correcting or adjusting journal entries related to the following information. For corrections, first prepare an entry reversing the original incorrect entry, then prepare the correct entry. Show the calculation of any amounts not included in the problem. Round intermediate calculations to 4 significant digits (e.g., 63.27%). If no journal entry is needed, write “No Entry Needed” and explain briefly why it is not needed.
1. During the first quarter of 2017, the company to which TECHNOGYM sold its West Coast division on Dec. 31, 2016 filed a lawsuit alleges that TECHNOGYM misrepresented the division's assets and liabilities. The plaintiff is seeking $2.4 million as an adjustment to the purchase price. TECHNOGYM’s attorneys advise that it is reasonably possible the company could lose $1 million, but that it's extremely unlikely it could lose the $2.4 million asked for.
Explanation / Answer
According to SFAS No. 5, recognition of a loss contingency, (which is what these anticipated claims represent), is required if both of the following conditions are met:
(a) It is probable that a liability has been incurred, and
(b) The amount of the loss can be reasonably estimated.
It appears in the article that both of these conditions are met. TECHNOGYM already a of lawsuits filed against. In addition, attorneys advise that it is reasonably possible the company could lose $1 million i.e the amount of its potential obligations.
(b) Loss from Estimated Asbestos Claims........... 1,000,000
Liability for Asbestos Claims..................... 1,000,000
The loss would be reported as a loss (not extraordinary) in the income statement. The liability would appear in TECHNOGYM’s balance sheet, probably as long term. Note disclosure would explain the nature of the contingency and how the obligation was estimated.