Contingencies
Loss and Gain
Loss Contingencies
•
An existing situation, by the end of the accounting period, could cause liabilities or fewer assets, if events continue
to play out in the same direction.
•
Examples – lawsuits, potential environmental fines, possible tax assessments and insurance claims, governmental
investigations, estimation of bad debts, etc.
•
Materiality versus immateriality
•
Levels of likelihood -- Probable, reasonably possible, remote
•
Journal entry if can reasonably estimate the loss, it is probable, and material (and use low end of range of estimates
unless one number is more likely than others)
•
Loss (expense) ……………………………………………………………..XX
•
Liability……………………………………………………………XX
•
Footnote if reasonably possible and material, or can’t estimate and probable and material
•
Do nothing if remote and/or not material
•
Some things are disclosed in footnotes no matter what – guarantees of other indebtedness, guarantees to
repurchase receivables
Gain Contingencies
•
A situation exists now in this accounting period that may increase assets or decrease
liabilities in a following period, dependent on future events related to the situation that
exists now.
•
Examples – our company is suing another company, tax disputes or insurance claims
(loss greater than book value) are resolving in our favor
•
Cannot journalize until earned Can be footnoted for disclosure if not misleading to
statement readers.
•
Normally recognized when realized.
Examples of contingencies
1.
Our company is suing a supplier for the material amount of $500,000. Our legal counsel estimate it
probable that they will settle out of court for between $350,000 and $400,000 with no one amount
known.
2.
We are being sued by a customer for the material amount of $1,000,000. Our legal counsel feels it is
probable that we will lose $800,000, the most likely amount, though the range could be $750,000 to
$850,000.
3.
The federal government is investigating us and it is reasonably possible that they will fine us the
material amount of $900,000 (the most likely amount in the range of $800,000 to $950,000).
4.
It is estimated that the material amount of $500,000 of our accounts receivable will not be collected,
since our most important customer was just declared bankrupt at the end of this year. There is
some chance that we will still collect .10 on the $1.00.
5.
There is a remote chance that the Environmental Protection Agency will give us a penalty for
improper waste removal, estimated to cost $1,000,000.
6.
Due to a city violation, it is probable that we will be fined next year for events occurring this year, for
an immaterial amount of $1,000.
Solutions to examples
ONE
Our company is suing a supplier for the material amount of $500,000. Our legal counsel
estimate it probable that they will settle out of court for between $350,000 and $400,000
with no one amount known.
Gain contingencies are not journalized until the revenue is finalized and earned. The most
that can be done is a footnote, if it is not misleading to statement readers.
Solutions to examples (continued-2)
Two
We are being sued by a customer for the material amount of $1,000,000. Our legal
counsel feels it is probable that we will lose $800,000, the most likely amount, though the
range could be $750,000 to $850,000.
It is a loss contingency that should be journalized.
Estimated Contingent Loss…………………………………800,000
Estimated Contingent liability………………………..…………….800,000
Solutions to examples (continued-3)
Three
The federal government is investigating us and it is reasonably possible that they will fine
us the material amount of $900,000 (the most likely amount in the range of $800,000 to
$950,000).
It is a loss contingency, but reasonably possible does not meet the threshold for journalizing,
even though material and able to estimate. It should be footnoted.
Solutions to examples (continued-4)
Four
It is estimated that the material amount of $500,000 of our accounts receivable will not
be collected, since our most important customer was just declared bankrupt at the end of
this year. There is a reasonable chance that we will still collect .10 on the $1.00.
Estimated Contingent Loss…………………………..450,000
Estimated Contingent liability………………………………………….450,000
500,000 - .10(500,000) = 450,000
Solutions to examples (continued-5)
Five
There is a remote chance that the Environmental Protection Agency will give us a penalty
for improper waste removal, estimated to cost $1,000,000.
Though a loss contingency, no need to disclose a material amount when it is extremely
unlikely to happen.
Solutions to examples (continued-6)
Six
Due to a city violation, it is probable that we will be fined next year for events occurring
this year, for an immaterial amount of $1,000.
Though a loss contingency, a material amount need not be disclosed.