Contingent Liability

Pay particular attention to expenses resulting from contingencies. A. Using the unadjusted trial balance and supplemental information for Sun Energy Co., construct an income statement for the year ended December 31, 2017.

• Working papers should be retained which show the collective summary of the detailed assessments performed by local teams, as these will support the final accounting entries and/or disclosures made.
• There are sometimes significant risks that are simply not in the liability section of the balance sheet.
• A business accounting journal is used to record all business transactions.
• Since the outcome is possible, the contingent liability is disclosed in Sierra Sports’ financial statement notes.
• This warranty is in effect until the end of Year Three.
• Patent wars that usually happen between Top brands give a clear-cut explanation.

If the company manufacturers 5000 machines a year and provides a warranty for each machine, the company would need to estimate how many machines they expect might be returned each year while covered by the warranty. They will debit the legal expenses account for the amount of $100,000 and credit the accrued expenses account for the amount of $100,000. When autocomplete results are available use up and down arrows to review and enter to select. Touch device users, explore by touch or with swipe gestures.

Measurement

Full BioAmy is an ACA and the CEO and founder of OnPoint Learning, a financial training company delivering training to financial professionals. She has nearly two decades of experience in the financial industry and as a financial instructor for industry professionals and individuals.

To illustrate, assume that a retail store sells ten thousand refrigerators during Year One for $400 cash each. The product is covered by a warranty that extends until the end of Year Three. No claims are made in Year One but similar programs in the past have resulted in repairs being made to 3 percent of the refrigerator at an average cost of $90.

Amendments under consideration by the IASB

If the liability is probable and the amount can be reasonably estimated, companies should record contingent liabilities in the accounts. The existence of the liability is uncertain and usually, the amount is uncertain because contingent liabilities depend on some future event occurring or not occurring. In this case, the contingent liability should be disclosed by the business in the footnotes of their financial statements. More information is now available, some of which might suggest that $14,000 is no longer the best number to be utilized for the final period of the warranty. As an illustration, assume that a design flaw has been found in the refrigerators and that $20,000 (rather than $14,000) is now the estimate of the costs to be incurred in the final year of the warranty. The reported figure must be updated to provide a fair presentation of the information that is now available. Estimations should be changed at the point that new data provide a clearer vision of future events.

Unfortunately, this official standard provides little specific detail about what constitutes a probable, reasonably possible, or remote loss. “Probable” is described in Statement Number Five as likely to occur and “remote” contingent liabilities is a situation where the chance of occurrence is slight. “Reasonably possible” is defined in vague terms as existing when “the chance of the future event or events occurring is more than remote but less than likely” .

Contingent liabilities

Therefore the accounting entry will be for USD 6 million and not just the USD 1 million increase in the year. Now that all relevant information has been received and reviewed, the Accounts Division can determine the accounting impact based on the information provided by OLA. The Accounts Division should instead maintain an excel sheet containing the key details regarding each significant contingent liability requiring disclosure. If a provision is discounted upon initial recognition, the discount must be ‘unwound’ at the end of each subsequent reporting period. Cash flows should only be discounted to their net present value when the impact is material.

Here, the company should rely on precedent and legal counsel to ascertain the likelihood of damages. Contingent liabilities are obligations that will become liabilities if certain events occur in the future. Companies do not know what the outcome of a lawsuit will be, which makes lawsuits a contingent liability. Businesses are required to record their contingent liabilities according to the Generally Accepted Accounting Principles and the International Financial Reporting Standards. Liabilities are debts owed by a business to the outsiders due to previous purchases or borrowings.