Importance of recording commitments, loss contigencies and estiamted liabilities in a financial statement

Expert Solution

Loss contingencies are potential losses that are both probable and for which amount can be estimated. This is recorded as a loss on the income statement. In case where a loss contingency is possible but not probable then it is not showed in financial statements but is rather disclosed in the notes to financial statements. If the loss contingency is probable or possible but the amount cannot be estimated then it cannot be recorded in books of accounts either as an expense or as a liability. Hence it will be disclosed in the notes to the financial statements.

Estimated liability is that debt or obligation for which the amount is unknown but can be reasonably estimated. Estimated liability, in other words, is a known liability for which the management does not have a way of finding out the exact amount of liability. A good example of this is employee benefit programs that are impossible to measure but can be reasonably estimated using factors like number of employees, employee retirement rates, employee compensation etc.

Commitment is the accounting method of setting aside funds that is done to earmark funds for a purchase that will take place in the near future. The funds so committed will remain tied until the imminent purchase is paid for. After the purchase is done the commitment amount becomes an expense.

The importance of recording loss contingencies, estimated liabilities and commitments is to ensure that the financial and accounting report of the company provides a fair and true representation of the actual financial health of the company. A company’s actual financial health is also dependent on uncertain future events and recording and reporting of loss contingencies, estimated liabilities and commitments will ensure that users of financial statements have a true picture of the company’s financial health. It will ensure that accounting principles of full disclosure, materiality and prudence are adhered to.

ekkarill92 answered 4 months ago

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