Question

Contingencies.

There are three different approaches 1) recorded ( or recognizes) as a liability. 2) disclosed(in the notes to the financial statement) 3)not recorded or disclosed.

Scenario

Batteries4U was a manufacturer of batteries, Portable lighting, and personal care products. Year 1(2009): it was identified as a "potentially responsible party" by a government environmental protection agency and told they might have to share in the cost of an environmental clean-up. Litigation was started. Batteries 4U though the probable outcome would be unfavorable. Year2(2010): Batteries4U was able to reasonably estimate the cost of the clean-up. What would be your approach in each year? Please provide your explanation.

Answer 1

Contingent liabilities need to pass two thresholds before they can be reported in the financial statements. First, it must be possible to estimate the value of the contingent liability. If the value can be estimated, the liability must have a greater than 50% chance of being realized. Qualifying contingent liabilities are recorded as an expense on the income statement and a liability on the balance sheet.

If the contingent loss is remote, meaning it has a less than 50% chance of occurring, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.

Year 1 (2009)

Since in this year it was only estimated that they might have to share the cost of environmental clean-up however the amount of cost is not reasonably estimated, so the liability would not be recorded or disclosed.

Year 2 (2010)

Since the amount is reasonably estimable in this year, so if it is probable that chance of incurring teh liability is more than 50% than the same should be recorded as liability in the financial statement otherwise it should be disclosed as the footnotes in the financial statement.

Note-

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