Question

A recently issued demographic report indicates that there is a reasonable probability that Lambert's business may be adversely impacted in the future. The company's controller wants to begin accruing a general contingency reserve now for unspecified business contingencies, such as the potential decline in business that may occur in the future. Find authoritative guidance as to whether or not such an accrual is allowed under GAAP. Please explain whether or not such an accrual is allowed.

Answer 1

Under GAAP, ASC 450, contingencies, gives the accounting and disclosure requirements for loss and gain contingencies.

It requires accrual by a charge to income (accrual) for an estimated loss from a loss contingency if two conditions are met:

(a) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and

(b) the amount of loss can be reasonably estimated.

Both the conditions are required to be completed.

Further, GAAP mentions that Accruals for general or unspecified business risks ("reserves for general contingencies") are not permitted.

So in the present case, even though Lambert's business is having reasonable probability that it will be adversely impacted, but there is no probability that any asset had been impaired or a liability has been incurred. Further, potential loss cannot be reasonably estimated.

Also, General contingency reserve for unspecified business contingencies are not permitted under GAAP. Hence, no such accrual is allowed.