Question

A company has the following legal claim against it at 12/31. Assuming these 3 possible scenarios, identify the accounting treatment for each claim as either:

A liability that needs to be recorded.

Or

A note in the company’s financial statements.

The company estimates the loss to be $500,000.

If the item is to be recorded, prepare the year end journal entry.

1. Reasonably estimated, but not a probable loss.

2. Probable loss, but can’t be reasonably estimated.

3. Can be reasonably estimated, and loss is probable.

Answer 1

Loss contingencies are reported on the balance sheet and footnotes on the financial statements, if they are probable and their quantity can be reasonably estimated. If both the conditions are met, loss contingency should be accrued.

1. A note in the company's financial statements, as it is not a probable loss.

2. A note in the company's financial statements, as it cannot be reasonably estimated.

3. A liability needs to be recorded, as both conditions are fulfilled.