M2 - Contingencies and Commitments

Question 1

Contingent liability must be disclosed in its financial statements at 12-31 (end of year). If the note is discounted WITH recourse, it is NOT discounted for footnote liability purposes because the the owner is contingently liable for the full amount because it was sold with recourse. (true or false)

Answer 1

True

Question 2

When should someone recognize warranty costs that are probable and estimable?

• Evenly over the life of the warranty
• The date of sale
• When payments are mad
• When service calls are performed

Answer 2

Date of sale

Question 3

Rule: Only footnote disclosure is required for a “reasonably possible” (not “probable”) loss. (true or false)

Answer 3

True

No amount should be accrued for losses that are only “reasonably possible”

Question 4

A contingent liability that is probable and estimable must be recognized. If all amounts within a range of values are equally likely, then the lowest amount in the range is the measurement amount. (true or false)

Answer 4

True

Question 5

For warranty’s, any change in the estimate of the percentage is recorded prospectively, from the current year forward. (true or false)

Answer 5

True

Question 6

Contingent liabilities which are remotely possible are neither accrued nor disclosed. However, related party transactions must be disclosed.(true or false)

Answer 6

true

Question 7

Only a loss that is reasonably possible will be accrued. (true or false)

Answer 7

False,

Only a loss that is probable and estimable will be accrued. Reasonably possible losses are disclosed in the notes only.

Question 8

Gain contingencies should be disclosed with care taken not to mislead users of the F/S as to the likelihood of realization. (true or false)

Answer 8

True

Gain contingencies are not accrued until the transaction generating the gain is completed.

Question 9

The contingent liability for a discounted note receivable is the (maturity value or discounted value)?

Answer 9

Maturity value. This should be disclosed.

Question 10

Gain contingencies are not recorded in the accounts since revenue is not recognized before realization. (True or false)

Answer 10

True

In this (question) case, that would be when the appeals process is complete and the award is collected.

Question 11

When a range of probable losses is given, GAAP requires that the best estimate of the loss be accrued. If no amount in the range is a better estimate than any other amount within the range, the minimum amount in the range should be accrued. (true or false)

Answer 11

True

Question 12

Example: Explosion happens from Dane Co. and damages is incurred on other area buildings. Dane Co. Concluded that it is probable and estimable that Dane Co will have a liability of $3,500,000. Dane’s $10,000,000 comprehensive public liability policy has a $500,000 deductible clause. Dane’s F/S should report this item as:

Answer 12

An accrued liability of $3,500,000. The insurance proceeds that may result would be treated as a gain contingency and not recorded until received.

Question 13

An increase in (expense, liability, or both) would result when a contingency is “probable” and the amount can be “reasonably estimated.”

Answer 13

BOTH,

Question 14

What is the underlying concept governing the GAAP pertaining to recording gain contingencies?

• Reliability
• Conservatism
• Consistency
• Relevance

Answer 14

Conservatism

Contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization. The accounting concept of conservatism applies: “anticipate all losses but not gains”

Question 15

A contingent liability that is PROBABLE but CANNOT be reasonably estimated should:

Answer 15

be disclosed in the F/S but not recorded as an adjustment in the F/S.

If a reasonable range of the loss cannot be estimated, then a statement saying such must be included in the notes.