Question

Contingent Liability

Facts:

• You are auditing a very successful and highly profitable manufacturing company as of December 31, 2020.
• The Company has always maintained adequate insurance in different areas. The Company has decided, effective January 1, 2021, not to purchase insurance against risk of loss that may result from injury to others, damage to the property of others, or interruption of its business operations.
• The Company would like to record a $5,000,000 reserve as of December 31, 2020 for claims associated with future events which may occur.

Required:

Should the Company record this $5,000,000 Reserve for Claims (a contingent liability) in its 12/31/2020 Financial Statements? Why or why not?

Answer 1

contingent events depends upon occurence or non-occurence of uncertain future events.The term contingent liability is also relate to same as well.

Contingent liability is disclosed if all the conditions mentioned below is satsfied:

1. There should be present obligation arises out of past events but same as not recognised as provision - in this case there is no present obligation as a result of past events
2. It is not probable that an outflow of resources embodying economic benefit will be required to settle the obligation - which means how much amount required to pay to settle the obligation cannot measure with certainity because of non-happpening of event.
3. The possibility of outflow is also remote - because it depends on future event.
4. Amount of obligation cannot measure with sufficient reliability to recognise them as provision - to recognise a provision there should be sufficient reliability in measuring amount of provision .

conclusion:

Based on above , In our case the accident will occur in the future which means f there is future event not past events. The first condtion of disclosing a contingent liability is not satisfied.The company should not recognise a contingent liability in its 12/31/2020 financial statement.