Question

Q1) Why should executory contracts be disclosed to financial statement users?

A. They call for some form of future performance, which creates an obligation for the reporting company
B. They represent a possible inflow of economic resources
C. They create current income tax obligations
D. They create an obligation contingent upon the occurrence of a past event

Q2) Which one of the following contingencies should most likely not be disclosed on Communications, Inc.’s financial statements until it has been resolved?
A. A lawsuit by Communications, Inc. against Overseas Communication Co. in which Communications, Inc. will likely win.
B. A lawsuit against Communications, Inc. for which it is probable that Communications, Inc. will lose.
C. A lawsuit against Communications, Inc. for which it is reasonably possible Communications, Inc. will lose.
D. All of the above should be disclosed on the financial statements.

Answer 1

Answer 1

Option A is correct.

This Standard does not apply to executory contracts unless they are onerous.

Answer 2

Option A is correct.

Companies often face situations where they may be liable for future financial payouts. This often occurs when another party, such as a customer or a vendor, sues the company. The final liability of the company depends on the outcome of the court proceedings. In some cases, the company needs to report this amount on its financial statements. When the company is likely to lose the proceedings and the amount of the liability can be estimated, the company needs to record this amount in its financial records and in its financial statements.

Even if it is probable that the plaintiff will win the case and receive a monetary award, it cannot recognize the contingent asset until such time as the lawsuit has been settled. Conversely, the other party that is probably going to lose the lawsuit must record a provision for the contingent liability as soon as the loss becomes probable, and should not wait until the lawsuit has been settled to do so. Thus, recognition of the contingent liability comes before recognition of the contingent asset.