While shopping on October 13, 2011, at the Floor Wax Shop, Tom Jacobs slipped and seriously injured his back. Mr. Jacobs believed that the Floor Wax Shop should have warned him that the floors were slick: hence, he sued the company for damages. As of December 31, 2011, the lawsuit was still in progress. According to the company’s lawyers, it was probable that the company would lose the lawsuit. The lawyers also believed that the company could low somewhere between $250,000 and $1.5 million, with a best guess of the loss at $742,000. The lawsuit was eventually settled in favor of Mr. Jacobs on August 12, 2012, for $690,000.

REQUIRED:

a. Discuss the issues that the Floor Wax Shop must address in deciding how to report this lawsuit in its 2011 financial report.

b. If you were auditing the Floor Wax Shop, bow would you recommend that this lawsuit be reported in the 2011 financial report? Why?

c. Assume that a contingent liability of $742,000 is accrued on December 31, 2011. What journal entry would the company record on August 12, 2012, the date of the settlement?