When deciding upon the appropriate accounting for a contingency, the basic concept is that you should only record a loss that is probable, and for which the amount of the loss can be reasonably estimated.
If it is not possible to arrive at a reasonable estimate of the loss associated with an event, only disclose the existence of the contingency in the notes accompanying the financial statements.
The recognition of a gain contingency is not allowed, since doing so might result in the recognition of revenue before the contingent event has been settled.
If the conditions for recording a loss contingency are initially not met, but then are met during a later accounting period, the loss should be accrued in the later period. Do not make a retroactive adjustment to an earlier period to record a loss contingency.
A liability in accounting is defined as a financial obligation that will result in the sacrifice of assets in the future. It includes long-term liabilities such as bonds and loans payable and current liabilities such as accounts payable or accrued expenses. But what about commitments an entity has made but for which no obligation exists on the balance sheet date? Or events or circumstances that took place or existed on the balance sheet date but with uncertain outcomes? Do these also qualify as liabilities? Let us look at the requirements for recognizing and disclosing these, and how we should go about identifying them.
When preparing the financial statements, entities must identify contingencies and commitments that should be recognized and disclosed. Documentation such as minutes of board and management meetings, contracts, and correspondence with lawyers, bankers and financiers should be examined to identify and classify contingencies and commitments. Attention should be paid to the terms of contracts, indications of the likelihood that liabilities will be incurred, and restrictions placed on the future use of resources by agreements entered into.
A liability in accounting is defined as a financial obligation that will result in the sacrifice of assets in the future. Contingencies are conditions or situations that exist on the balance sheet date, but whose outcome depends on uncertain future events. Loss contingencies are contingencies that can result in the entity suffering possible losses. They are recognized as liabilities if it is probable that a loss will be incurred and the amount can be reasonably estimated. If a loss is reasonably possible but not probable, details of the contingency must be disclosed. Gain contingencies are contingencies that may result in the entity receiving an asset. They are never recognized and only disclosed if highly probable. Details of certain commitments should also be disclosed in the financial statements. Commitments are obligations an entity has to third parties, often as the result of a legal agreement. Commitments are not recognized but must be disclosed in the financial statements.
Loss contingencies are contingencies that can result in the entity suffering possible losses depending on the outcome of the future event, and their recognition depends on the likelihood of it incurring these losses. The accounting treatment of loss contingencies can be summarized as follows:
Contingencies in accounting can be defined as conditions or situations that exist on the balance sheet date, but whose outcome depends on uncertain future events. Think for instance of a lawsuit an entity is involved in. The existence of an asset or liability on the balance sheet date depends on the outcome of the legal action, which is uncertain on that date.
Documentation should be examined up to the date the financial statements are published, as events after the balance sheet date can provide more information about commitments and contingencies on the balance sheet date.
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When deciding upon the appropriate accounting for a contingency, the basic concept is that you should only record a loss that is probable, and for which the amount of the loss can be reasonably estimated. If the best estimate of the amount of the loss is within a range, accrue whichever amount appears to be a better estimate than the other estimates in the range. If there is no “better estimate” in the range, accrue a loss for the minimum amount in the range.
The accounting for a contingency is essentially to recognize only those losses that are probable and for which a loss amount can be reasonably estimated. Examples of contingent loss situations are:
The recognition of a gain contingency is not allowed, since doing so might result in the recognition of revenue before the contingent event has been settled.