Reporting Requirements of Contingent Liabilities and GAAP Compliance

Two FASB recognition requirements must be met before declaring a contingent liability. There must be a probable likelihood of occurrence, and the loss amount is reasonably estimated.

• The useful economic life is two years, with a residual value of $13,000.
• The accounting of contingent liabilities is a very subjective topic and requires sound professional judgment.
• As reversing manual JVs are used to make the Umoja entry, the Accounts Division should first check that provisions recognized in previous reporting periods have been reversed during the current reporting period.
• ____ Restatement of financial statements should occur if a company attempts to mislead investors by understating its liabilities.
• An addendum of examples of typical events after the reporting date can also be included within the closing instructions to assist staff in identifying such events.

In this adjusting entry, the change in the expense is not recorded in the period of the sale. As discussed earlier, no retroactive changes are contingent liabilities made in previously reported figures unless fraud occurred or an estimate was held to be so unreasonable that it was not made in good faith.

FRC publishes thematic review findings on IAS 37

A disclosure note provides the reader of the financial statements with more information about a certain account value. It’s the accountant’s way of explaining why they did something. For contingencies to be recorded, wording is very important. To be recorded on the balance sheet, the likelihood of the loss needs to be probable and the amount of the future payment needs to be known. The accounting of contingent liabilities is a very subjective topic and requires sound professional judgment. Contingent liabilities can be a tricky concept for a company’s management, as well as for investors.

She now believes that an additional $17,000 should be added. Note that no expense was estimated and recorded in connection with this warranty. As explained by the matching principle, no expense is recognized until the revenue begins to be reported. At the end of Year Two, the warranty payable T-account in the general ledger holds a balance of $14,000 ($27,000 original estimation less $13,000 payout for repairs to date). Because the warranty has not expired, company officials need to evaluate whether this $14,000 liability is still a reasonable estimation of the remaining costs to be incurred. A debt that is expected to be satisfied within one year from the date of the balance sheet is classified as a current liability.In upper-level accounting courses, the definition of a current liability is refined a bit.

Recognition of a provision

The existence of the liability is uncertain and usually the amount is uncertain because contingent liabilities depend on some future event occurring or not occurring. When liabilities are contingent, the company usually is not sure that the liability exists and is uncertain about the amount. However, since most contingent liabilities may not occur and the amount often cannot be reasonably estimated, the accountant usually does not record them in the accounts. Instead, firms typically disclose these contingent liabilities in notes to their financial statements. Many companies incur contingent liabilities as a result of product warranties. If the warranty is given to a customer along with a purchased item, an anticipated expense should be recognized at that time as well as the related liability. If the cost of this type of embedded warranty eventually proves to be incorrect, the correction is made when discovered.

Let’s explore the likelihood of occurrence requirement in more detail. On receipt of this information, the Accounts Division will then review to ensure that it is accurate and complete, and supported by relevant documentation. The review conducted by the Accounts Division should include a comparison between prior and current year measurement. Once expenses have been identified, the Accounts Division should ensure that these expenses are relevant to the provision raised. Depending on the nature of the provision, the JV may debit an asset account .

What Are Contingent Liabilities in Accounting?

You must disclose all contingencies that could significantly alter the company’s estimated earnings. Explain any obscure or potentially misleading items in the footnotes. You should also use the footnotes to discuss any contingent liabilities incurred between the initial creation of the financial statements and publication of the final version. Machine Corp. has several pending lawsuits against its company. This financial recognition and disclosure are recognized in the current financial statements. The income statement and balance sheet are typically impacted by contingent liabilities. For our purposes, assume that Sierra Sports has a line of soccer goals that sell for $800, and the company anticipates selling 500 goals this year .

For a financial figure to be reasonably estimated, it could be based on past experience or industry standards (see ). It could also be determined by the potential future, known financial outcome. Above indicates relevant stakeholders that may be responsible to provide information on provisions, contingent liabilities and contingent assets as part of the Accounts Division information request and review process. In addition, a contingent liability for USD 3,000,000 was disclosed in the notes to the financial statements . Reductions are due to a case no longer meeting the provisions recognition criteria, which will be a reversal, and the provision for the case in question will be derecognized from the financial statements. The request should clearly indicate that the provisions recognition criteria should be assessed for each reported case at the end of each reporting period to determine whether cases still meet the recognition requirements.

ICAS report on IAS 37 and decommissioning liabilities

The accounting rules for the treatment of a contingent liability are quite liberal – there is no need to record a liability unless the risk of loss is quite high. Thus, you should review the disclosures accompanying a company’s financial statements to see if there are additional risks that have not yet been recognized. These disclosures should be considered advance warning of amounts that may later appear as formal liabilities in the financial statements. “Reasonably possible” means that the chance of the event occurring is more than remote but less than likely. Assume that Sierra Sports is sued by one of the customers who purchased the faulty soccer goals. A settlement of responsibility in the case has been reached, but the actual damages have not been determined and cannot be reasonably estimated. This is considered probable but inestimable, because the lawsuit is very likely to occur but the actual damages are unknown.

• A contingent liability must be recognized and disclosed if there is a probable liability determination before the preparation of financial statements has occurred, and the company can reasonably estimate the amount of loss.
• Thus, you should review the disclosures accompanying a company’s financial statements to see if there are additional risks that have not yet been recognized.
• The accounting rules were made to ensure that people reading the financial statements would be given enough information.
• To illustrate, assume that on August 8, Year Two, a slight adjustment must be made to the television at a cost of $9.
• They are completely dependent on the occurrence of an event in the future anytime.