In: Accounting
The two basic requirements for the accrual of a loss contingency are supported by several basic concepts of accounting. Four of these concepts are periodicity (time periods), measurement, objectivity, and relevance.
Required:
Discuss how the two basic requirements for accrual of a loss contingency relate to the four concepts listed in the case description.
Please indicate FASB ASC references in the answer.
The two basic requirements for accrual of a loss contingency are probability and measurement. By probability the requirement is that there should be real chances of an event and also chances of loss. The requirement of measurement means that the value of such loss must be estimable.
The first concept is that of periodicity and as per this concept all the incomes, expenses, assets and liability should be estimated for a certain period. So accrual of a loss contingency should be created in that period itself in which the loss is probable to occur. For example allowance for bad debt is created at the end of the year as it is during the year that the probability of loss due to bad debt exists.
The second concept is the measurement concept and as per this concept only those amount that can be measured in terms of money has to be recorded. This is also the requirement directly connected with accrual of a loss contingency where the estimated loss must be measurable.
The third concept is the objectivity concept and as per this concept accounting decisions should be free of biases and should rather be based on measurable assessments that can be supported by additional evidence. Here the subjective method describes the possibility of including accrual of a loss of contingency.
Relevance is associated with information that is timely, useful, has predictive. So once these estimates are made for accrual of contingency they carry the qualities of timeliness, usefulness and prediction.
Reference: FASB ASC 450-20.