Reporting Requirements of Contingent Liabilities and GAAP Compliance

Other ContingenciesOther examples of contingencies include environmental damages, possible tax assessments, insurance losses, and government investigations. Sunoco, for instance, reports that “federal, state and local laws … result in liabilities and loss contingencies. Sunoco accrues … cleanup costs are probable and reasonably estimable.

But external auditors will assess the company’s existing classifications and accruals to determine whether they seem appropriate. They’ll also look out for new contingencies that aren’t yet recorded. During fieldwork, your auditors may ask for supporting documentation and recommend adjustments to estimates and disclosures, if necessary, based on current market conditions. Record keeping is a must for small business owners, and recording contingent liabilities in your business’ accounting books is one of them! While the amount might not be completely determined, you can still avoid errors by at least making note that the company might have a pending debt.

IFRIC 1 — Changes in Existing Decommissioning, Restoration and Similar Liabilities

Take the example of a famous lawsuit of Apple vs. Samsung, where Apple sued Samsung for technology theft and violating patent rights. Apple claimed $2.5 billion when the lawsuit began in 2011 but won over $500 million in the final verdict in 2018. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), its global network of member firms and their related entities. DTTL (also referred to as “Deloitte Global”) and each of its member firms are legally separate and independent entities.

Any probable contingency needs to be reflected in the financial statements—no exceptions. Possible contingencies—those that are neither probable nor remote—should be disclosed in the footnotes of the financial statements. If the lawsuit is frivolous, there may be no need for disclosure. Any case with an ambiguous chance of success should be noted in the financial statements but do not need to be listed on the balance sheet as a liability.

Why is a Contingent Liability Recorded?

The likelihood of loss is described as probable, reasonably possible, or remote. The ability to estimate a loss is described as known, reasonably estimable, or not reasonably estimable. Entities often make commitments that are future obligations that do not yet qualify as liabilities that must be reported. For accounting purposes, they are only described in the notes to financial statements. Contingencies are potential liabilities that might result because of a past event.

The likelihood of occurrence and the measurement requirement are the FASB required conditions. A contingent liability must be recognized and disclosed if there is a probable liability determination before the preparation of financial statements has occurred, and the company can reasonably estimate the amount of loss. Record a contingent liability when it is probable that the loss will occur, and you can reasonably estimate the amount of the loss. If you can only estimate a range of possible amounts, then record that amount in the range that appears to be a better estimate than any other amount; if no amount is better, then record the lowest amount in the range. “Probable” means that the future event is likely to occur. You should also describe the liability in the footnotes that accompany the financial statements. Record a contingent liability when it is probable that a loss will occur, and you can reasonably estimate the amount of the loss.

Do Not Disclose a Contingent Liability

If the company’s year ends on Wednesday, an adjustment is necessary so that the expense on the income statement and the liability on the balance sheet are both presented fairly for the three contingent liabilities days that have passed. The following adjustment is made for $30,000 ($10,000 per day for three days) so that the debt incurred for salaries in the first year is reported properly.