Question

5. Argo Motor Company, a motorcycle manufacturer, had the following contingencies: a. Argo estimates that it is reasonably possible that it will lose a current lawsuit. Argo’s attorneys estimate that the potential loss will be $2,200,000. b. Argo received notice that it is being sued. Argo is advised by its attorneys that the lawsuit is considered frivolous. c. Argo is currently the defendant in a lawsuit. Argo believes it is probable that it will lose the lawsuit. Estimated damages to be paid will be between $70,000 - $100,000. Argo’s attorneys believe the judge will award the plaintiff approximately $90,000. d. Argo recently filed a lawsuit against the manufacturer of a brake pedal used in a popular motorcycle sold by Argo, which had to be recalled due to a defective braking system. Argo is seeking damages of $1,500,000. Argo feels confident that it will be awarded the full amount of damages it is seeking. Determine the appropriate accounting treatment for each of Argo’s contingencies.

Answer 1

Contingent liability is a liability or a potential loss that may occur in the future depending on the outcome of a specific event

a. Argo estimates that it is reasonably possible that it will lose a current lawsuit. Argo’s attorneys estimate that the potential loss will be $2,200,000. This is a "high probability" contingency is a liability where  both probable of actually occurring and one where the costs can be reasonably estimated and therefore the company must disclose the estimated amount of the potential loss and also describe the contingency in the footnotes of its financial statements.

b. Argo received notice that it is being sued. Argo is advised by its attorneys that the lawsuit is considered frivolous. This qualifies other contingent liabilities as low probability. The likelihood of these contingent liabilities actually triggering a cost is very low, and therefore accountants are not required to report them in the financial statements.

c. Argo is currently the defendant in a lawsuit. Argo believes it is probable that it will lose the lawsuit. Estimated damages to be paid will be between $70,000 - $100,000. Argo’s attorneys believe the judge will award the plaintiff approximately $90,000.This is medium probability" contingency where one that falls short of either but not both of the parameters of a high probability liability. These liabilities must be disclosed in the footnotes of the financial statements if either of two criteria are true. First, if the contingency is probable but the company cannot estimate the loss, or second, if the contingency the contingency is reasonably possible, although not necessarily probable.

d. Argo recently filed a lawsuit against the manufacturer of a brake pedal used in a popular motorcycle sold by Argo, which had to be recalled due to a defective braking system. Argo is seeking damages of $1,500,000. Argo feels confident that it will be awarded the full amount of damages it is seeking. This is a contingent gain where potential increase in assets that has not yet occurred. A contingent gain is not recognized in the financial statements until the transaction has been settled