Question

1. In late 2018, Macrosoft Company was sued for patent infringement related to a new software product. At year-end, the company’s attorney advises that a loss is probable under this lawsuit, but it is not currently possible to reasonably estimate such amount.

a. What treatment would this contingent liability receive in the company’s December 31, 2018 financial statement?

b. Assume the same facts as above, but assume that this lawsuit was settled for $5 million after the end of the year, but before the financial statements were issued. How would your answer above change?

Answer 1

Contingent Liability refers to a potential liability that may occur in the future depending on the outcome of the uncertain future event.

Contingent Liability is recognized, if the following two conditions are satisfied.

• The liability is likely to occur
• The Liability amount can be reasonably estimated.

If it is not possible to reasonably estimate the Liability Amount, the contingent Liability shall be disclosed in the footnotes of the Financial Statements.

Question -a:

In this case, the loss is probable but not possible to reasonably estimate the Liability Amount. Hence, Macrosoft Company shall disclose in its notes to Financial Statements, the details of the Contingent Liability and shall disclose that the amount of liability cannot be reasonably estimated.

Question -b:

In this case the loss is probable and the amount of Contingent Liability can be reasonably estimated i.e. $ 5 millions, Hence the Company shall recognize the expense of $ 5 millions in its Financial Statements