Potter’s accountant believes the financial statements will be misleading if the probable loss contingency is not disclosed. How much should be disclosed, and how much should be accrued in Potter’s financial statements for the current year?

Complete Question:

Potter Co. has the following contingencies, all resulting from lawsuits in progress during the current year:

Probable loss contingency $1,500,000; Reasonably possible loss contingency 500,000; Probable gain contingency 700,000; Reasonably possible gain contingency 300,000.

Potter's accountant believes the financial statements will be misleading if the probable loss contingency is not disclosed. How much should be disclosed, and how much should be accrued in Potter's financial statements for the current year?

A. Disclosed $1,000,000 gain

Accrued $1,500,000 loss & $500,000 loss

B. Disclosed $500,000 loss & $1,000,000 gain

Accrued$1,500,000 loss & $700,000 gain

C. Disclosed $2,000,000 loss & $1,000,000 gain

Accrued $1 ,500,000 loss

D. Disclosed $500,000 loss & $300,000 gain

Accrued $1,500,000 loss

Option C Disclosed $2,000,000 loss & $1,000,000 gain

Accrued $1 ,500,000 loss

Explanation:

All the gains that are certain which means that are more than 95% chances of gain then it must be realized as gain otherwise it must be ignored. In this case, there is no gain that is reasonably certain. So the realized gain amount is zero. On the other hand, the liabilities must be realized when the chances of occurrence of the outcome is probable or certain which in this case is $1,500,000 and must be recognized as increase in liability.

Furthermore, the gains which are reasonably probable and possible gains must be disclosed in the financial statement. In this case the probable and possible gain are $700,000 and $300,000. This means that the amount $1,000,000 must be recognized as possible gain. And on the other hand, possible and probable losses must be disclosed in the financial statement which in this case are $1,500,000 probable losses and $500,000 possible losses. So the amount that must be disclosed as losses are $2,000,000.

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