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

Answer 1

Black Water Inc. should accrue a loss contingency of $125,000,000, which is the most probable cost estimated by the company's lawyers, and disclose an additional contingency of up to $75,000,000 in the financial note disclosures.

Step-by-step explanation:

Based on the information that Black Water Inc.'s lawyers have determined it is probable that the company will lose a lawsuit and be found liable for a judgment costing between $100,000,000 to $200,000,000, with the most probable cost being $125,000,000, the accounting treatment should follow the guidance set out by accounting standards for loss contingencies. These standards typically require that a loss be accrued when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Here, the company has a reasonable estimate of the most probable amount, $125,000,000. Therefore, Black Water should accrue a loss contingency of $125,000,000. As for the additional potential amount of the contingency, this should be disclosed in the notes to the financial statements to inform users about the potential liability range beyond the accrued amount.