Section 3C - Contingencies and Commits Flashcards
- During Year 2, a former employee of Dane Co. began a suit against Dane for wrongful termination in November of Year 1. After considering all of the facts,
- Dane’s legal counsel believes that the former employee will prevail and will probably receive damages of between $1,000,000 and $1,500,000, with $1,300,000 being the most likely amount.
- Dane’s financial statements for the year ended December 31, Year 2, will not be issued until February of Year 3. In its December 31, Year 2, balance sheet, what amount should Dane report as a liability with respect to the suit?
$1,500,000
$1,000,000
$0
$1,300,000
$1,300,000
A loss contingency must be accrued if it is probable that the loss will occur and the amount can be reasonably estimated.
If a range of loss can be estimated, the best estimate within the range is accrued. Since legal counsel believes that $1,300,000 is the most likely amount to be collected, Dane should report this amount as a liability.
A loss contingency must be accrued if it is ___that the loss will occur and the amount can be ___.
Contingent losses are ___when probable or reasonably probable.
Contingent ___are not accrued but should be ___when probable or ___probable.
probable , reasonably estimated
disclosed
gains , disclosed , reasonably
Potter Co. has the following contingencies, all resulting from lawsuits in progress during the current year:
- Probable loss contingency $1,500,000
- Reasonably possible loss contingency 500,000
- Probable gain contingency 700,000
- Reasonably possible gain contingency 300,000
Potter’s accountant believes the financial statements will be misleading if the probable loss contingency is not disclosed. How much should be disclosed, and how much should be accrued in Potter’s financial statements for the current year?
- Disclosed: $1,000,000 gain; Accrued: $1,500,000 loss and $500,000 loss
- Disclosed: $2,000,000 loss and $1,000,000 gain; Accrued: $1,500,000 loss
- Disclosed: $500,000 loss and $1,000,000 gain; Accrued: $1,500,000 loss and $700,000 gain
- Disclosed: $500,000 loss and $300,000 gain; Accrued: $1,500,000 loss
Disclosed: $2,000,000 loss and $1,000,000 gain; Accrued: $1,500,000 loss
Contingent losses are accrued when probable and reasonably estimable. Contingent losses are disclosed when probable or reasonably probable. Contingent gains are not accrued but should be disclosed when probable or reasonably probable.
Only the reasonably probable loss should be accrued ($1,500,000). All of the gains and losses should be disclosed (Losses: $1,500,000 + $500,000 = $2,000,000, Gains: $700,000 + $300,000 = $1,000,000).
+____ are usually not reflected in the accounts, since to do so would be to recognize revenue prior to its realization. Adequate disclosure is made of gain contingencies but care must be taken to avoid misleading implications.
Gain contingencies
Probability of Occurrence___Accrual Requiremnet____Disclosure requirement
Probable___??___??
Reasonable Probable___??___??
Remote___??___??
Accrual Requirement___Disclosure Requirement
Probable: Accrue if reasonably estimated (if not, then just disclose)__disclose the nature & amount
Reasonable PRobable: No accrual __ nature and estimate of loss (or statement that no estimate is probable)
Remote: No accrual __ (right ot proceed against an outside party?)
In 20X1, a personal injury lawsuit was brought against Halsey Co. Based on counsel’s estimate, Halsey reported a $50,000 liability in its December 31, 20X1, balance sheet. In November 20X2, Halsey received a favorable judgment, requiring the plaintiff to reimburse Halsey for expenses of $30,000. The plaintiff has appealed the decision, and Halsey’s counsel is unable to predict the outcome of the appeal.
In its December 31, 20X2, balance sheet, Halsey should report what amounts of asset and liability related to these legal actions?
Asset: $0; Liability: $20,000
Asset: $30,000; Liability: $0
Asset: $30,000; Liability: $50,000
Asset: $0; Liability: $0
Asset: $0; Liability: $0
FASB ASC 450-20-25-2 provides for:
- accrual of a loss if such loss is probable and can be reasonably estimated, and
- no accrual of gains.
Since the outcome of the appeal cannot be predicted, no asset (gain) should be reported. Since Halsey received a favorable judgment, the liability accrued in 20X1 is no longer appropriate. (And the legal costs have probably already been expensed.) However, the lawsuit and appeal should be disclosed in a footnote.
Which of the following methods should a company use to account for a contingent liability when the loss is probable but not reasonably estimated?
The liability should be reported as a short-term liability.
The liability should be reported as a long-term liability.
The liability should only be disclosed in the notes to the financial statements.
The liability should not be reported.
The liability should only be disclosed in the notes to the financial statements.
- Proper accounting for loss contingencies requires an assessment of the probability that a future event or events will confirm a loss or asset impairment or the incurrence of a liability as of the date of the financial statements. If the future event is likely to occur, it is considered probable
- . Losses that are probable should be accrued only if the loss is reasonably estimable.
- If the loss cannot be reasonably estimated, the nature of the contingency should be disclosed in the notes to the financial statements.
Daniel Company is embroiled in a lawsuit with an individual investor. If the probability of loss from the lawsuit is remote, a loss contingency should be:
disclosed and accrued as a liability.
neither accrued as a liability nor disclosed.
accrued as a liability but not disclosed.
disclosed but not accrued as a liability.
neither accrued as a liability nor disclosed.
FASB ASC 450-20-25-2 requires that when the probability of a loss is remote, the loss contingency is neither accrued nor disclosed. When a loss is probable and the amount of such loss can be reasonably estimated, the loss contingency should be accrued. When a loss is reasonably possible, a loss contingency should be disclosed but not accrued.
Bell Co. is a defendant in a lawsuit that could result in a large payment to the plaintiff. Bell’s attorney believes that there is a 90% chance that Bell will lose the suit, and estimates that the loss will be anywhere from $5,000,000 to $20,000,000 and possibly as much as $30,000,000. None of the estimates are better than the others. What amount of liability should Bell report on its balance sheet related to the lawsuit?
$0
$30,000,000
$20,000,000
$5,000,000
$5,000,000
If it is probable that a liability has been incurred, but no point in the range of estimated loss is more probable than any other, a company must record a loss and liability for the lowest point of the range. The company must also disclose the range of possible loss in accordance with FASB ASC 450-20-30-1.
The absence of insurance does not mean that an asset has been impaired or a liability incurred T/F – would this require a disclosure? NOPE!
Accruals for general risk contingencies do not meet the conditions for accrual and should/should not be made.
true
should not
A prerequisite for accrual of a loss contingency is that the amount can be reasonably __
This does not require, however, that a single amount can be estimated. If a range of loss can be estimated, the best estimate within the range is accrued. t/f
If no amount within the range is a better estimate than any other amount, the minimum amount in the __is accrued and the estimated range of potential loss disclosed.
estimated.
true
range
During 20X1, Smith Co. filed suit against West, Inc., seeking damages for patent infringement. On December 31, 20X1, Smith’s legal counsel believed that it was probable that Smith would be successful against West for an estimated amount in the range of $75,000 to $150,000, with all amounts in the range considered equally likely. In March 20X2, Smith was awarded $100,000 and received full payment thereof. In its 20X1 financial statements, issued in February 20X2, how should this award be reported?
As a disclosure of a contingent gain of an undetermined amount in the range of $75,000 to $150,000
As a receivable and deferred revenue of $100,000
As a disclosure of a contingent gain of $100,000
As a receivable and revenue of $100,000
As a disclosure of a contingent gain of an undetermined amount in the range of $75,000 to $150,000
FASB ASC 450-30 reads:
- “A contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization.” (FASB ASC 450-30-25-1)
- “Adequate disclosure shall be made of contingencies that might result in gains, but care shall be exercised to avoid misleading implications as to the likelihood of realization.” (FASB ASC 450-30-50
Smith Co.’s financial statements should include a disclosure of a contingent gain with a range of $75,000 to $150,000.
Ace Co. settled litigation on February 1, 20X2, for an event that occurred during 20X1. An estimated liability was determined as of December 31, 20X1. This estimate was significantly less than the final settlement. The transaction is considered to be material. The financial statements for year-end 20X1 have not been issued. How should the settlement be reported in Ace’s year-end 20X1 financial statements?
Disclosure only of the settlement
Neither a disclosure nor an accrual
Only an accrual of the settlement
Both a disclosure and an accrual
Both a disclosure and an accrual
Post-balance sheet events (subsequent events) should be explained in the notes to the financial statements when the event is significant. FASB ASC 855-10-55-1 contains guidance about the recognition of subsequent events: “An entity must recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.”
A ___is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain ___) or loss (loss ___) to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.
Financial statements are considered issued when they are widely distributed to shareholders and other financial statement users for general use and reliance in a form and format that complies with GAAP. t/f
A public entity includes private companies controlled by a public company . t/f
A private company can file with the SEC
contingency
true
true
false -only public
In October 20X2, Hake paid $375,000 to a former employee to settle a lawsuit out of court. The lawsuit had been filed in 20X1, and on December 31, 20X1, Hake had recorded a liability from lawsuit based on legal counsel’s estimate that the loss from the lawsuit would be between $250,000 and $750,000. Compute the amount of gain or loss from settlement of the lawsuit in 20X2.
Hake would not record a gain or loss upon settlement of the lawsuit since a contingent loss had already been recorded.
Hake would record a $375,000 gain.
Hake would record a $125,000 gain.
Hake would record a $125,000 loss.
Hake would record a $125,000 loss.
Hake would record a loss on the settlement of the lawsuit of $125,000, calculated as follows:
20X2 Payment - 20X1 Contingent Liability = 20X2 Loss
$375,000 - $250,000 = $125,000
On December 31, 20X1, Hake would have recorded a contingent liability of $250,000 (the minimum estimate of loss, since no amount within the range of estimates was identified as being a better estimate that any other) in accordance with FASB ASC 450-20-30-1.
Blythe Corp. is a defendant in a lawsuit. Blythe’s attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency?
No disclosure or accrual
Accrued but not disclosed
Disclosed but not accrued
Accrued and disclosed
Disclosed but not accrued
If the possibility that a company will be required to pay a contingent liability is reasonably possible, the liability is not required to accrue the liability. However, the nature of the liability and an estimate of the loss (or range of loss) must be disclosed.
A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, by a material amount. Which of the following accounting treatments is most appropriate?
- Neither describe the purchase obligation nor recognize a loss on the income statement or balance shee
- Describe the nature of the contract in a note to the financial statements, recognize a loss in the income statement, and recognize a reduction in inventory equal to the amount of the loss by use of a valuation account
- Describe the nature of the contract and the estimated amount of the loss in a note to the financial statements, but do not recognize a loss in the income statement
- Describe the nature of the contract in a note to the financial statements, recognize a loss in the income statement, and recognize a liability for the accrued loss
describe the nature of the contract in a note to the financial statements, recognize a loss in the income statement, and recognize a liability for the accrued loss
Expenses are generally recognized when an enterprise’s economic benefits are consumed in revenue-earning activities or otherwise. Expenses or losses are recognized if it becomes evident that previously recognized future economic benefits of assets have been reduced or eliminated, or that liabilities have been incurred or increased, without associated economic benefits.
In this case, a loss is recognized because it has become evident that previously recognized future economic benefits of assets have been reduced without any associated economic benefits.
If unconditional purchase obligations have not been recognized (recorded) as a liability on the balance sheet, the purchaser must disclose:
- ___and term of the obligation
- The ___of the fixed and determinable portion of the obligation(s)
- The nature of any variable __of the obligation(s)
- The amounts ___under the obligation(s) for each period for which an income statement is presented
Disclosure of the present value of these unrecorded unconditional purchase obligations is encouraged but not required. t/f
nature
amount
components
purchased
true
On January 1, 20X1, Card Corp. signed a 3-year, noncancelable purchase contract, which allows Card to purchase up to 500,000 units of a computer part annually from Hart Supply Co. at $.10 per unit and guarantees a minimum annual purchase of 100,000 units. During 20X1, the part unexpectedly became obsolete. Card had 250,000 units of this inventory at December 31, 20X1, and believes these parts can be sold as scrap for $.02 per unit. What amount of probable loss from the purchase commitment should Card report in its 20X1 income statement?
$20,000
$16,000
$24,000
$8,000
$16,000
Minimum purchase commitment for 20X2 and 20X3
(100,000 units x $.10/u x 2 years)$20,000
Less scrap recovery (100,000 units x $.02 x 2 years 4,000
Probable loss from purchase commitment $16,000
Note: The question asks for the probable loss from purchase commitment (i.e., the loss for the remaining two years on the contract). The loss on the 250,000 units already in inventory is not considered part of this loss; it would be reported as an operating loss due to the write-down of inventory due to obsolescence.
Conlon Co. is the plaintiff in a patent infringement case. Conlon has a high probability of a favorable outcome, and can reasonably estimate the amount of the settlement. What is the proper accounting treatment of the patent infringement case?
A gain contingency for the minimum estimated amount of the settlement
A gain contingency for the estimated probable settlement
No reporting is required at this time.
Disclosure in the notes only
Disclosure in the notes only
Since Conlon is the plaintiff (they are suing), a gain contingency exists. Gain contingencies are not recognized since they have not been realized (conservatism).
On February 5, 20X1, an employee filed a $2,000,000 lawsuit against Steel Co. for damages suffered when one of Steel’s plants exploded on December 29, 20X0. Steel’s legal counsel expects the company will lose the lawsuit and estimates the loss to be between $500,000 and $1,000,000. The employee has offered to settle the lawsuit out of court for $900,000, but Steel will not agree to the settlement. In its December 31, 20X0, balance sheet, what amount should Steel report as liability from lawsuit?
$2,000,000
$1,000,000
$500,000
$900,000
$500,000
FASB ASC 450-20-25 provides the following guidance when the estimated loss is in a range of values: When no amount within the range is a better estimate than any other amount, it is required that the minimum amount in the range shall be accrued.
Thus, Steel Co. should report a liability from the lawsuit in the amount of $500,000, the minimum amount in the range.
On September 12, 20X5, an employee filed a $1,500,000 lawsuit against Friedman Corporation for damages suffered when the employee was wrongfully dismissed from his employment in 20X3. Friedman’s legal counsel expects the company will lose the lawsuit.
They believe the actual loss will be between $750,000 and $1,250,000. In an effort to avoid a trial, the employee offered to settle the lawsuit for $1,100,000.
In its December 31, 20X5, balance sheet, what amount should Friedman report as liability from lawsuit?
$750,000
$1,500,000
$1,250,000
$1,100,000
$750,000
FASB ASC 450-20-25 provides the following guidance when the estimated loss is in a range of values: When no amount within the range is a better estimate than any other amount, it is required that the minimum amount in the range shall be accrued.
Thus, Friedman Corporation should report a liability from the lawsuit in the amount of $750,000, the minimum amount in the range.
- During January of the current year, Haze Corp. won a litigation award for $15,000 which was tripled to $45,000 to include punitive damages.
- The defendant, who is financially stable, has appealed only the $30,000 punitive damages.
- Haze was awarded $50,000 in an unrelated suit it filed, which is being appealed by the defendant. Counsel is unable to estimate the outcome of these appeals.
In its current year financial statements, Haze should report what amount of pretax gain?
- $15,000
- $45,000
- $50,000
- $95,000
$15,000
Both of these lawsuits are gain contingencies, which are generally not recognized until it is virtually certain that there are rights to receive the amounts involved. Thus, the amounts that are yet to be received, and subject to the uncertainty of an appeal process, should not be recognized yet.
However, the $15,000 award that has not been appealed can be taken now as pretax gain.
- Baker Co. sells consumer products that are packaged in boxes. Baker offered an unbreakable glass in exchange for two box tops and $1 as a promotion during the current year.
- The cost of the glass was $2. Baker estimated at the end of the year that it would be probable that 50% of the box tops will be redeemed. Baker sold 100,000 boxes of the product during the current year and 40,000 box tops were redeemed during the year for the glasses.
What amount should Baker accrue as an estimated liability at the end of the current year, related to the redemption of box tops?
$25,000
$5,000
$0
$20,000
$5,000