Question

Black Water Inc. is being sued by former employees as a result of negligence on the company's part. Black Water's lawyers state that it is probable that the company will lose the suit and be found liable for a judgment costing the company anywhere from $100,000,000 to $200,000,000. However, the lawyer states that the most probable cost is $125,000,000. As a result of the above facts, Black Water should accrue

A. a loss contingency of $100,000,000 and disclose an additional contingency of up to $100,000,000.
B. a loss contingency of $125,000,000 and disclose an additional contingency of up to $75,000,000.
C. a loss contingency of $125,000,000 but not disclose any additional contingency.
D. no loss contingency but disclose a contingency of $100,000,000 to $200,000,000.

Answer 1

Black Water Inc. should accrue a loss contingency of $125,000,000, being the most probable cost of the lawsuit as estimated by their lawyers, and disclose an additional contingency of up to $75,000,000. The correct answer is option b.

Step-by-step explanation:

When a company is facing a lawsuit, accounting principles require that certain conditions must be met before a loss contingency can be accrued on the company's financial statements. In the case of Black Water Inc., which is being sued for negligence and where it seems probable that they will lose, they must estimate the loss and account for it in their financial statements. The lawyers have estimated that the most probable cost to the company from the lawsuit will be $125,000,000.

According to accounting standards, the company should record a loss contingency for the amount that represents the best estimate of the financial implication of the lawsuit. Hence, Black Water should accrue a loss contingency of $125,000,000.

Any additional possible loss over this amount should be disclosed in the notes to the financial statements, so the answer is that Black Water should accrue a loss contingency of $125,000,000 and disclose an additional contingency of up to $75,000,000. Therefore, the correct option is B. a loss contingency of $125,000,000 and disclose an additional contingency of up to $75,000,000.