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Question - The Heinrich Tire Company recalled a tire in its subcompact line in December 2021. Costs associated with the recall were originally thought to approximate $41 million. Now, though, while management feels it is probable the company will incur substantial costs, all discussions indicate that $41 million is an excessive amount. Based on prior recalls in the industry, management has provided the following probability distribution for the potential loss:
Loss Amount
Probability
$31 million
20%
$21 million
50%
$11 million
30%
An arrangement with a consortium of distributors requires that all recall costs be settled at the end of 2022. The risk-free rate of interest is 5%.
Required -
1. By the traditional approach to measuring loss contingencies, what amount would Heinrich record at the end of 2021 for the loss and contingent liability? For the remainder of this problem, apply the expected cash flow approach of SFAC No. 7. Estimate Heinrich's liability at the end of the 2021 fiscal year.
2. Prepare the necessary journal entries.
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