Read the following scenario and determine the proper accounting and financial reporting treatment of potential legal liabilities related to the case described. Reference criteria for recording contingent liabilities as outlined by generally accepted accounting principles in your explanation.

A coal mining company has been blamed for causing a large fish kill in a river near one of its mines. The states environmental protection agency claims that the company did not have proper safeguards in place to prevent chemicals from the mine leaking into the river. The company vehemently denies this charge and has readings from its equipment that shows discharges from the mine were well within prescribed limits. Nevertheless, the state has assessed a $10 million penalty on the company.

The company maintains its innocence and is filing an appeal that will be heard early in the next fiscal year. The companys legal counsel feels it is probable that the state will reduce the penalty but that total removal of the penalty is unlikely. Legal counsel estimates that the reduced penalty will be between $4 and $6 million.

You are the Chief Financial Officer and must decide how the company accounts for and reports the potential legal liability. You will need to report your decision to the companys executive team and the audit committee of the board of directors as it will have a significant impact on financial results. Defend your decision in your report.