You are the independent auditor engaged to audit Millay Corporations December 31, 2016 financial statements. Millay manufactures household appliances. During the course of your audit, you discovered the following contingent liabilities.

(a) Millay began production of a new dishwasher in June 2016, and by December 31, 2016, it sold 120,000 to various retailers for $500 each. Each dishwasher is under a one-year warranty. The company estimates that its warranty expense per dishwasher will amount to $25. At year-end, the company had already paid out $1,000,000 in warranty expenses. Millays income statement shows warranty expenses of $1,000,000 for 2016. Millay is on the accrual method of accounting.

(b) Morgan Sondgeroth, Esq., the Companys attorney, has informed Millay that it has been cited for dumping toxic waste into the Kishwaukee River. Clean-up costs and fines amount to $2,750,000. Although the case is still being contested, Sondgeroth is certain that Millay will most probably have to pay the fine and clean-up costs. No disclosure of this situation was found in the financial statements.

(c) Millay is the defendant in a patent infringement lawsuit by Megan Drabek over Millays use of a hydraulic compressor in several of its products. Sondgeroth claims that, if the suit goes against Millay, the loss may be as much as $5,000,000; however, Sondgeroth believes the loss of this suit to be only reasonably possible. Again, no mention of this suit is made in the financial statements.

As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report.

REQUIRED: For each situation, describe why the current presentation is not in accordance with GAAP and what the correct presentation would be.