Contingencies Fallon Company, a toy manufacturer that also operates several retail outlets, is preparing its December 31, 2016, financial statements. It has identified the following legal situations that may qualify as contingencies: 

  

1. A customer is suing the company for $800,000 in damages because her child was injured in November 2016while riding an escalator that stopped suddenly in one of its stores. The child was hurt when he tripped and fell while walking ‘‘down’’ an escalator that was going ‘‘up.’’ Legal counsel feels that the child is partially at fault, but that it is probable that the lawsuit will be settled for between $50,000 and $100,000, with $80,000 being the most likely amount. 

  

2. Fallon has discovered that a skateboard it began manufacturing and selling in 2016has defective bearings, sometimes causing a wheel to fall off. Fallon has issued a ‘‘recall’’ notice in newspapers and magazines in which it offers to replace the bearings. It estimates a cost of $200,000 for these repairs. No lawsuits have been filed for injury claims, although the company feels that there is a reasonable possibility that claims may total as high as $2 million. 

  

3. Fallon has an incinerator behind one of its retail outlets which is used to burn cardboard boxes received in shipments of inventory from suppliers. The state environmental protection agency filed suit against the company in August 2016for air pollution. Fallon expects to stop using the incinerator and begin recycling. However, its lawyers believe that it is probable that a fine of between $40,000 and $60,000 will be levied against the company, although they cannot predict the exact amount. 

  

4. In early 2016, Fallon signed a contract with a computer vendor to install ‘‘state of the art’’ cash registers in all of its retail outlets. Because of the vendor’s inability to acquire sufficient cash registers, the vendor canceled the contract. Fallon has filed a breach of contract suit against the vendor, claiming $300,000 in damages. The company’s lawyers expect that it will settle the suit ‘‘out of court’’ for $150,000. 

  

Required: 

1. Next Level For each situation, prepare the journal entry (if any) on December 31, 2016, to record the information for Fallon, and explain your reasoning. If no journal entry is recorded, explain how the information would be disclosed in Fallon’s 2016 annual report.

2. How would your answers change if Fallon used IFRS?

Answer rating: 100% (QA)

1 To record the litigation loss occurred due to damages occurred to the products sold to the custome... View the full answer