23 4 Contingencies Leave a comment

If the contingent liability is probable and inestimable, it is likely to occur but cannot be reasonably estimated. In this case, a note disclosure is required in financial statements, but a journal entry and financial recognition should not occur until a reasonable estimate is possible. (Figure)Roundhouse Tools has several potential warranty claims as a result of damaged tool kits. A contingency occurs when a current situation has an outcome that is unknown or uncertain and will not be resolved until a future point in time. A contingent liability can produce a future debt or negative obligation for the company. Some examples of contingent liabilities include pending litigation (legal action), warranties, customer insurance claims, and bankruptcy.

  1. The key accounting rule related to gain contingencies is that they should not be recognized until it is virtually certain that they will be realized.
  2. For example, Sierra Sports has a one-year warranty on part repairs and replacements for a soccer goal they sell.
  3. If the contingencies do occur, it may still be uncertain when they will come to fruition, or the financial implications.
  4. If the contingent liability is probable and inestimable, it is likely to occur but cannot be reasonably estimated.

These are questions businesses must ask themselves when exploring contingencies and their effect on liabilities. Warranties arise from products or services sold to customers that cover gain contingency certain defects (see (Figure)). It is unclear if a customer will need to use a warranty, and when, but this is a possibility for each product or service sold that includes a warranty.

Please Sign in to set this content as a favorite.

Liquidity and solvency are measures of a company’s ability to pay debts as they come due. Liquidity measures evaluate a company’s ability to pay current debts as they come due, while solvency measures evaluate the ability to pay debts long term. One common liquidity measure is the current ratio, and a higher ratio is preferred over a lower one. This ratio—current assets divided by current liabilities—is lowered by an increase in current liabilities (the denominator increases while we assume that the numerator remains the same).

Gain Contingency

Our example only covered the warranty expenses anticipated from the 2019 sales. Since the company has a three-year warranty, and it estimated repair costs of $5,000 for the goals sold in 2019, there is still a balance of $2,200 left from the original $5,000. If it is determined that too much is being set aside in the allowance, then future annual warranty expenses can be adjusted downward. If it is determined that not enough is being accumulated, then the warranty expense allowance can be increased. If a contingency may result in a gain, it is allowable to disclose the nature of the contingency in the notes accompanying the financial statements.

Understanding Gain Contingencies

Reporting the contingency’s nature and the approximate amount of money involved is required. A contingency refers to a condition, situation, or set of circumstances where it is uncertain whether or not a gain or loss will occur in the future. The result of the current condition, situation, or set of circumstances, is unknown until future events occur (or do not occur). Contingencies are different from estimates, even though both involve a level of uncertainty. Calculating depreciation using an estimated useful life or amounts accrued for services received are not contingencies. A gain contingency is an uncertain situation that will be resolved in the future, possibly resulting in a gain.

Gain contingencies should be disclosed with caution to prevent giving the wrong impression that income is recognized before it is actually realized. Zebra should therefore be transparent about its legal dispute with Lion, which is expected to have a positive outcome the following year. The potential gain from a gain contingency is not recorded in accounting since the exact amount is unknown. If the gain is anticipated to be large, it can be mentioned in the financial statement’s notes.

Furthermore, Lion’s lawyers believe Lion will settle the lawsuit in the coming year, paying between $4.5 million and $8.5 million. When determining if the contingent liability should be recognized, there are four potential treatments to consider. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

Keep up-to-date on the latest insights and updates from the GAAP Dynamics’ team on all things accounting and auditing. Learn how Offer in Compromise can relieve tax debt stress and revive your business. These materials were downloaded from PwC’s Viewpoint (viewpoint.pwc.com) under license.

Google, a subsidiary of Alphabet Inc., has expanded from a search engine to a global brand with a variety of product and service offerings. Check out Google’s contingent liability considerations in this press release for Alphabet Inc.’s First Quarter 2017 Results to see a financial statement package, including note disclosures. According to the FASB, if there is a probable liability determination before the preparation of financial statements has occurred, there is a likelihood of occurrence, and the liability must be disclosed and recognized. This financial recognition and disclosure are recognized in the current financial statements. The income statement and balance sheet are typically impacted by contingent liabilities.

There is a probability that someone who purchased the soccer goal may bring it in to have the screws replaced. Not only does the contingent liability meet the probability requirement, it also meets the measurement requirement. In addition, Lion should disclose the contingency, if material, in its year-end financial statements along with the range of potential loss (i.e. $4.5 million to $8.5 million). Pending litigation involves legal claims against the business that may be resolved at a future point in time. The outcome of the lawsuit has yet to be determined but could have negative future impact on the business.

Leave a Reply

Your email address will not be published. Required fields are marked *