Irwin Inc. Self-Insurance Plan and Financial Statements Effects

Effects of Irwin Inc.'s Lawsuit on 1996 Financial Statements

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Question

Irwin Inc. has a self-insurance plan. Each year, retained earnings is appropriated for contingencies in an amount equal to insurance premiums saved minus recognized losses from lawsuits and other claims. As a result of a 1996 accident, Irwin is a defendant in a lawsuit in which it will probably have to pay damages of

$190,000. What are the effects of this lawsuit's probable outcome on Irwin's 1996 financial statements?

Answers

Explanations

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A. B. C. D. E.

C

Since the outcome of the lawsuit is probable and estimable, the amount of $190,000 will be recorded in the financial statements as a contingent liability and an expense.

Based on the information provided, Irwin Inc. has a self-insurance plan, which means it assumes the financial risk of its own losses instead of purchasing insurance from an external provider. Each year, Irwin appropriates retained earnings for contingencies, which is an amount equal to insurance premiums saved minus recognized losses from lawsuits and other claims.

In this case, Irwin is a defendant in a lawsuit arising from a 1996 accident, and it is probable that Irwin will have to pay damages amounting to $190,000.

The effects of this lawsuit's probable outcome on Irwin's 1996 financial statements can be determined as follows:

  1. Expenses: The probable outcome of the lawsuit will lead to an increase in expenses. Irwin will need to record the estimated damages of $190,000 as an expense on its income statement. This expense represents the cost incurred by Irwin due to the lawsuit.

  2. Liabilities: The probable outcome of the lawsuit will also result in an increase in liabilities. Irwin will need to recognize a liability for the estimated damages of $190,000 on its balance sheet. This liability represents the obligation or debt owed by Irwin as a result of the lawsuit.

Therefore, the correct answer is A. An increase in expenses and no effect on liabilities. The lawsuit's probable outcome leads to an increase in expenses (recording the damages as an expense) but does not directly affect liabilities since Irwin already appropriated retained earnings for contingencies, which accounts for recognized losses from lawsuits and other claims.

Please note that this explanation is based on the information provided and the context of the question. In an actual financial statement analysis, additional information and specific accounting principles may need to be considered for a comprehensive assessment.

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