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FASB Statement No. 5 defines a contingency as “an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.” There are three GAAP-specified categories of contingent liabilities: probable, possible, and remote.
The following two examples from annual reports are typical of the disclosures made in notes to the financial statements. Be aware that just because a suit is brought, the company being sued is not necessarily guilty. One company included the following note in its annual report to describe its contingent liability regarding various lawsuits against the company: Contingent Liabilities
Another company dismissed an employee and included the following note to disclose the contingent liability resulting from the ensuing litigation: Contingencies
You can view the transcript for “Accounting Tutorial Contingent Liabilities Training Lesson 4.7” here (opens in new window). PRACTICE QUESTIONHow is a contingent liability reported if it is considered reasonably possible?If a contingent loss is reasonably possible, it falls somewhere between remote and probable. Here, the company must disclose it but doesn't need to record an accrual. The disclosure should include an estimate of the amount (or the range of amounts) of the contingent loss or an explanation of why it can't be estimated.
When contingent liability is probable?A contingent liability is a potential liability that may occur in the future, such as pending lawsuits or honoring product warranties. If the liability is likely to occur and the amount can be reasonably estimated, the liability should be recorded in the accounting records of a firm.
When the amount of a contingent liability can be reasonably estimated and its likelihood is probable the company should?When the amount of a contingent liability can be reasonably estimated an its likelihood is probable, the company should: Record the estimated amount of the liability on the balance sheet.
What is the accounting requirement for contingent liabilities that are probable but not reasonably estimable?If a liability is possible or probable, but no reasonable estimation of the loss can be made, the company must disclose the nature of the contingency and state that such an estimate cannot be made.
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