Question

. During 2018, a former employee of Staple Company filed a lawsuit alleging age discrimination and asking for damages of $500,000. At December 31, 2018,Staple's legal counsel indicated that the likelihood of losing the lawsuit was possible but not probable and a good estimate for any potential loss is approximately $250,000 based on previous experience with similar cases. How should this suit be handled on the 2018 financial statements?

Answer 1

As per the GAAP, the accounting treatment of a contingent loss depends upon the category of contingent loss. Contingent loss can be classified as

1. Probable Loss: A probable loss refers to a situation in which the future event that will result in losses is likely to occur. In such a scenario, a provision is created for the reliable estimate of the loss after making adjustment of counter claim or counter against third party.
2. Reasonably Possible: A contingent liability is classified under this category when the chances of future event resulting in losses is more than remote but less than likely. In such a scenario, a footnote is inserted with the financial statements regarding the liability.
3. Remote: If the expected losses from the happening of an event are remote, it will be considered as business risk and ignored for accounting purpose.

In the present case, the likelihood of  losing the lawsuit is possible but not probable. Hence, it will be classified in the category of reasonably possible contingent liabilities. Therefore, a footnote should be inserted with the financial statements for the year ending December 31, 2018 discussing the lawsuit and indicating the estimate amount of potential loss of $250,000.