Question

Three GAAP-specified categories of contingent liabilities exist: probable, possible and remote. In general probable contingencies are more than likely to occur and can be reasonably appraised. Possible contingencies are less than likely of being realized, nevertheless they are not necessarily considered unlikely as well. Remote contingencies are not likely to occur.

Respond to the following in a minimum of 175 words:

• Discuss the two main distinctions between assets on the balance sheet.
• Discuss reporting requirements for contingencies.
• Explain two examples of contingent liabilities

Answer 1

Develop the discussion using the following key points.

1. Discuss the two main distinctions between assets on the balance sheet.

- Two main distinctions between assets on the balance sheet are Current Assets and Non-current Assets.
- Current assets are assets used in the short-term.
- It contain all of the assets that are likely to be converted into cash within one year.
- Current assets are used to fund ongoing operations and pay current expenses.
- It include cash, inventory, prepaid expenses ,accounts receivables, etc.
- Current assets represent all the assets of a company that are expected to be conveniently sold, consumed, used, or exhausted through standard business operations with one year.

-Noncurrent assets are company’s long-term investments or assets that have a useful life of more than one year.
- These assets usually last for several years.
- Non-current assets can't be easily liquidated into cash.
Long-term assets are considered noncurrent assets and the two terms are used interchangeably.
- It include tangible assets like property, plant and equipment, intangible assets like patent, Long term investments, etc.
- Investment in non- current assets are not realized within one year, so their costs depreciated over the years or their useful lives.
- Noncurrent assets for a company are important to investors because the assets might be long-term investments used for expansion or the launch of a new product line.

2. Discuss reporting requirements for contingencies.

- Under GAAP, a contingent liability is defined as any potential future loss that depends on a "triggering event" to turn into an actual expense.

- It's important that shareholders and lenders be warned about possible losses—an otherwise sound investment might look foolish after an undisclosed contingent liability is realized.
- There are three GAAP-specified categories of contingent liabilities: probable, possible, and remote. Probable contingencies are likely to occur and can be reasonably estimated. Possible contingencies do not have a more-likely-than-not chance of being realized but are not necessarily considered unlikely either. Remote contingencies aren't likely to occur and aren't reasonably possible.
- A probable contingency needs to be reflected in the financial statements without any exception. Remote contingencies should never be included. Contingencies that are neither probable nor remote should be disclosed in the footnotes of the financial statements.
- Contingent liabilities must pass two thresholds before they can be reported in financial statements: it must be possible to estimate the value of the contingent liability, and 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.

3. Explain two examples of contingent liabilities

Two examples of contingent liabilities include a company warranty and a lawsuit against the company. Both represent possible losses to the company, yet both depend on some uncertain future event.

Company guarantee: A company gave a bank guarantee on behalf of a subsidiary. For the past 3 years, this has been shown as a contingent liability. Now in the current financial year, the subsidiary company went through a financial crisis and is almost on the verge of bankruptcy. Then in such a case, this is no more a contingent liability. Now the company must consider this as a provision or even as a liability and pass the necessary accounting entries to recognize this.

A lawsuit against the company: If a lawsuit is filed against a company, and the plaintiff claims damages up to $200,000. It's impossible to know whether the company should report a contingent liability of $200,000 based solely on this information. Here, the company should rely on precedent and legal counsel to ascertain the likelihood of damages. If a court is likely to rule in favor of the plaintiff, whether because there is strong evidence of wrongdoing or some other factor, the company should report a contingent liability equal to probable damages.