Contingent Liabilities

Several months ago, Cinnabar Chemical Company experienced a hazardous materials spill at one of its plants. As a result, the Environmental Protection Agency (EPA) fined the company $1,249,500. The company is contesting the fine. In addition, an employee is seeking $412,000 damages related to injuries sustained while cleaning up the spill. Lastly, a homeowner has sued the company for $278,000. The homeowner lives 15 miles from the plant but believes that the incident has reduced the home's resale value by $278,000.

Cinnabar's legal counsel believes that it is probable that the EPA fine will stand. In addition, counsel indicates that an out-of-court settlement of $257,500 has recently been reached with the employee. The final papers will be signed next week. Counsel believes that the homeowner's case is much weaker and will be decided in favor of Cinnabar. Other litigation related to the spill is possible, but the damage amounts are uncertain.

a.Illustrate the effects of the contingent liabilities associated with the hazardous materials spill on the accounts and financial statements. If no account or activity is affected, select "No effect" from the dropdown list and leave the corresponding number entry box blank. Enter account decreases and cash outflows as negative amounts

Statement of Cash Flows

Balance Sheet

Income Statement

Assets=

Liabilities+

Stockholders' Equity

=

+

+

Statement of Cash FlowsIncome Statement

b.If other litigation related to the spill is possible, but the damage amounts are uncertain, which of the following is the best course for Cinnabar to follow in its reporting?