Reference no: EM131067605

The Heinrich Tire Company recalled a tire in its subcompact line in December 2016. Costs associated with the recall were originally thought to approximate $50 million. Now, though, while management feels it is probable the company will incur substantial costs, all discussions indicate that $50 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 Loss Amount Probability $ 40 million 20 % $ 30 million 50 % $ 20 million 30 % An arrangement with a consortium of distributors requires that all recall costs be settled at the end of 2017. 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 2016 for the loss and contingent liability? 2 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 2016 fiscal year. 3 Prepare the journal entry to record the contingent liability (and loss). 4 Prepare the journal entry to accrue interest on the liability at the end of 2017. 5 Prepare the journal entry to pay the liability at the end of 2017, assuming the actual cost is $31 million. Heinrich records an additional loss if the actual costs are higher or a gain if the costs are lower.