Barry Company has a calendar year-end. On December 15, Year 1, a customer was injured using a product manufactured by Barry. That customer files a lawsuit against Barry on January 15, Year 2. On February 15, Year 2, Barry’s attorney advises Barry to settle the claim for $100,000 because a loss in that amount is probable and material. Barry has not yet distributed its Year 1 financial statements. What must Barry do with regards to those financial statements?

Record the loss contingency in the December 31, Year 1, balance sheet and also disclose the lawsuit in the footnotes.

Explanation:

Since the loss is both probable and material, then it must be recorded as a liability in the balance sheet. This is a loss contingency, and depending on whether the probability of occurrence is probable, possible or not possible, and the amount can be determined, then it will be recorded in the balance sheet, included in the footnotes or not considered.

Since the loss is probable and it can be quantified, plus the incident occurred during last year, then the loss contingency must be included as a liability. The company should also disclose the lawsuit in the footnotes.

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-lavira : )