Contingent Liabilities

Facts:

Before year end, a companys truck driver is involved in a three-vehicle wreck. One of the injured passengers in a separate vehicle is suing everyone involved. The company is being sued for $4 million. The company has $2 million of liability insurance. The Companys outside legal counsel states in writing that it is unable to express an opinion as to the likelihood of an unfavorable outcome to the company or the amount of any potential loss.

A company has been involved in ongoing litigation with one of its competitors for many years. Before the end of the year being audited, the outside legal counsel sends a letter to the companys owners stating that it is probable that the company will have to make a payment to the plaintiff to settle the litigation. However, the law firm could only say that it is probable the company will have to pay somewhere between $75,000 and $200,000 in the settlement.

Required: For both cases discussed above, answer two questions:

1. Should the company record a loss reserve at year end, and if so, for how much?

2. Should the company disclose this matter in the footnotes to the companys financial statements at year end?