Accounting Chapter 13, Chapter 13: Current Liabilities and Contingencies

The existence of the liability is uncertain and usually, the amount is uncertain because contingent liabilities depend (or are contingent) on some future event occurring or not occurring. When liabilities are contingent, the company usually is not sure that the liability exists and is uncertain about the amount. An example of determining a warranty liability based on apercentage of sales follows. The sales price per soccer goal is$1,200, and Sierra Sports believes 10% of sales will result inhonored warranties. The company would record this warrantyliability of $120 ($1,200 × 10%) to Warranty Liability and WarrantyExpense accounts. Assume that a company is facing a lawsuit from a rival firm for patent infringement.

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This analysis aims to predict the implications of these potential risk factors. They could be lawsuits, warranty claims, product liabilities, environmental cleanup costs, or any unforeseen expenses that may arise in the future. Under the GAAP, a business should record a contingent liability in its financial records when the liability is likely and able to be estimated. Conversely, under IFRS, these are recognized when an outflow of resources embodying economic benefits has become probable. A business should provide a disclosure note to describe the contingent liability, even if it is not recognized, so long as its occurrence is more than remote. In conclusion, measuring contingent liabilities involves determining the fair value and present obligation of future events, both of which are subject to estimations and judgement.

• Correctly match the accounting treatment with the specific scenario described.InstructionsDrag and drop application.Loss is probable and reasonably estimable.Loss is probable and reasonably estimable.
• A proactive and strategic approach is crucial in mitigating the potential financial risks caused by contingent liabilities.
• To help ensure transparency when reporting contingencies, companies must maintain thorough records of all contingencies.
• 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.

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Under U.S. Generally Accepted Accounting Principles (GAAP), some contingent losses may be reported on the balance sheet and income statement, while others are only disclosed unearned revenue in the footnotes. A contingent liability is a liability that may occur depending on the outcome of an uncertain future event. Contingent liabilities are recorded if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements unless both conditions are not met. For our purposes, assume that Sierra Sports has a line of soccer goals that sell for $800, and the company anticipates selling 500 goals this year (2019). Past experience for the goals that the company has sold is that 5% of them will need to be repaired under their three-year warranty program, and the cost of the average repair is $200.

• Possible contingencies that are neither probable nor remote should be disclosed in the footnotes of the financial statements.
• In conclusion, measuring contingent liabilities involves determining the fair value and present obligation of future events, both of which are subject to estimations and judgement.
• In conclusion, contingent liabilities are unpredictable and can significantly impact a company’s net income and financial health.
• 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.
• In this situation, no journal entry or note disclosure in financial statements is necessary.

Contingencies

Their presence can immensely affect the valuation of a business and structure the negotiation of the deal. The fair value of a contingent liability can be quite challenging to determine. Fair value is defined as the price that would be received to sell an asset or paid Food Truck Accounting to transfer a liability in an orderly transaction between market participants at the measurement date.

• This increases transparency and helps these stakeholders make informed decisions.
• In addition to fair value, the measure of ‘present obligation’ is also crucial in the accounting for contingent liabilities.
• However, the commitment will only actualize when a certain uncertain future event occurs.
• If it is determined that too much is being set aside in the allowance, then future annual warranty expenses can be adjusted downward.
• The sales price per soccer goal is$1,200, and Sierra Sports believes 10% of sales will result inhonored warranties.