Smith Security Systems’ revenues for 2012 totaled $25.8 million. As with most companies, Smith is a defendant in lawsuits related to its products. Note 14 of the Smith Annual Report for 2012 reported the following:
14. Contingencies
The company is involved in various legal proceedings.... It is the Company’s policy to accrue for amounts related to these legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable.

Requirements
1. Suppose Smith’s lawyers believe that a significant legal judgment against the company is reasonably possible. How should Smith report this situation in its financial statements?
2. Suppose Smith’s lawyers believe it is probable that a $3 million judgment will be rendered against the company. Report this situation in Smith’s financial statements. Journalize any entry requirements by GAAP. Explanations are not required.