Question

Explain the accounting treatment for each problem and what does the firm needs to do from an accounting perspective?

1. The company will likely lose a lawsuit, but an amount is not reasonably estimable at this time.

2. The company will likely lose a lawsuit and can reasonably estimate the amount at $2.3M.

3. The company faces a lawsuit and believes there is little chance of losing the case. The amount the company would have to pay is $10M.

4. The company believes it is possible they will lose a lawsuit and can estimate the amount at $8M.

Answer 1

1.

For a contingent loss, the accounting treatment is determined by likely outcome of such contingency. In case it is likely that such contingency would result in the loss of the business, then it is prudent to account for such loss in the enterprise financial statements. Since here likelihood of loss is confirmed but amount is not estimable we should have to recognize loss and a disclosure should be made in Financial Statement.

In case there is insufficient or conflicting evidence for assessing the value of the contingent loss, then the disclosure in financial statements is provided for the nature and existence of the contingency and should be also disclosed in notes. Codification 450-20. Under GAAP, a contingent liability is defined as any potential future loss that depends on a "triggering event" to turn into an actual expense.

2. If amount is reasonably certain, we should have to recognize loss of the estimated amount and a disclosure should be made in Financial Statement and in notes with 2.3M$

3. If the contingent loss is remote, meaning it has a less than 50 percent 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. If the lawsuit occurance is remote, there may be no need for disclosure. Any case with an ambiguous chance of success should be noted in the financial statements but need not be listed as a liability on the balance sheet.

4.If amount is reasonably certain, we should have to recognize loss of the estimated amount and a disclosure should be made in Financial Statement and in notes with 8M$ and also check going concern effect. If it is affecting going concern then it should be reported in Financial statement, Auditors Report, and Disclosure to shareholders.