Question

Rich Networks Inc. is being sued by a competitor for infringing on one of its competitor's patents. The company’s fiscal year end date is December 31. The suit for $95,000 was filed in court on January 30, 2020 before the company expects to submit its 2019 annual report to its regulatory body on February 25, 2020. The company’s legal counsel estimates that the likelihood of damages being awarded to the competitor is 80%. How much contingent liabilities, if any, should be reported on the balance sheet in the company’s 2019 annual report? If you think that the amount is zero, put 0. Otherwise, if you think that the amount is above zero, put that number in your answer.

I would think that the amount of contingent liabilities that could be report would be $95,000 since the likelihood of damages being awarded to the competitor is 80% and that the amount of  $95,000 was given to us, am I right?

Answer 1

A contingent liability is a liability that may occur depending on the outcome of an uncertain future event. A contingent liability is recorded if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements unless both conditions are not met.

Contingent liabilities, liabilities that depend on the outcome of an uncertain event, must pass two thresholds before they can be reported in financial statements. First, it must be possible to estimate the value of the contingent liability. If the value can be estimated, the liability must have greater than a 50% chance of being realized. Qualifying contingent liabilities are recorded as an expense on the income statement and a liability on the balance sheet.

If the contingent loss is remote, meaning it has less than a 50% chance of occurring, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.

Here Rich Networks Inc. is being sued by a competitor for infringing on one of its competitor's patents. The company’s fiscal year end date is December 31. The suit for $95,000 was filed in court on January 30, 2020 before the company expects to submit its 2019 annual report to its regulatory body on February 25, 2020. The company’s legal counsel estimates that the likelihood of damages being awarded to the competitor is 80%.

Here the liability is both probable and easy to estimate, the firm posts an accounting entry on the balance sheet to debit (increase) legal expenses for $95000 and to credit (increase) liability for $95000.

Quest

How much contingent liabilities, if any, should be reported on the balance sheet in the company’s 2019 annual report? If you think that the amount is zero, put 0. Otherwise, if you think that the amount is above zero, put that number in your answer.

Answer : Zero amount for contingent liabilities should be reported