(Learning Objective 1: Reporting a contingent liability) L&M Electronics’ revenues for 20X3 totaled $25.9 million. As with most companies, L&M is a defendant in lawsuits related to its products. Note 14 of the L&M Annual Report for 20X3 reported: The company is involved in various legal proceedings. It is the Company’s policy to accrue for amounts related to these legal matters if it is probable that a liability has been incurred and an amount is reasonably estimable.
Required
1. Suppose L&M’s lawyers believe that a significant legal judgment against the company is reasonably possible. How should L&M report this situation in its financial statements?
2. Suppose L&M’s lawyers believe it is probable that a $2 million judgment will be rendered against the company. Report this situation in L&M’s financial statements. Journalize any entry required by GAAP. Explanations are not required.