Question

Contingent Liabilities - A company is sued prior to the financial statement date. Before the financial statements are issued, the suit is settled for $750,000, a material loss for the company. Should the company record loss reserve at the year-end, if so for how much?

Please reference the appropriate accounting standards or other professional pronouncements  

Answer 1

Contingent Liabilities- Material Loss

it is an liabilities that may be incurred by an entity depanding on the outcome of an uncertain future events. it may in the form of outcome of the pending lawsuit. such libilities are not rcorded in the company's accounts and shown in the balance sheet where both the probable and reasonably estimate as contigency or worst case which from the result of financial outcome.

A footnote to the balance sheet may decribe the nature and extend of the contigent liabilities , the loss is decribed as probabel , reasonably possible or remote and also ability to estimate a loss is decribed a known , reasonably estimable are not reasonably estimables.

Contigent liabilitie sare never recorded in a financial statement of company . These obligation have not occured yet but there possibility of occuring in future so we can say that contigent liability has no accounting treatement.

However, company follow conservatioon approach to accouonting and follow the practice of disclosure , a proviion is a liability which can only bemeasured using certain degree of estimation , this means taht obligation is already present but the amount is not certain and only estimates can be determined, then in such a case ,we make a provision for such liability .

In order to report in financial statement first it must be posible to estimate the value of contigent liabilty and the liability must have greater than 50% chance of being realised , qualifying contigent liabilities are recordd as an expense on income statement and on a liability on balance sheet.

If contigent liability is a remote that is less than 50% chance of occuring the liability should not be reflected on the balance sheet.

There are three GAAP specified categories of contigent liablities

- probable

- possible

- remote

Example - supose a lawsuit is file against a company , and the plaintiff claim damges of certain amount so its impossible for a company to remote a contigent liability based on this  information . Under this company should rely on legal council to uncertain the damage.

If court is likely to rule inf avour of plaintiff, because of strong evidence then company should report a contigent liability equal to probable damage , this is true even if company has liability insurance

According to gap , three possible categories whereas probable contigencies are likely to occur and can be reasonably estimated but possible contigencies do not have more lilkely then not chance of being relised and remote contigency are not likely to occur and are not reasonably possible.