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Impact of Contingent Liabilities on Financial Reporting and Decision-Making
Professor: March 24, 2024
Enterprises function within an ever-evolving landscape where unforeseen circumstances
can affect financial information. Generally Accepted Accounting Principles (GAAP) and
International Financial Reporting Standards (IFRS) require companies to disclose contingent
liabilities and potential future obligations that can significantly affect their financial position to
represent their financial standing accurately (Palmer,2024). As per FASB codification 450-20-05-
2 alongside Subtopics 450-10- and 450-30, general guidance is offered regarding gain and loss
contingencies. Stakeholders, including investors and creditors, must be informed about these
potential liabilities, as they can influence the Company's risk exposure, cash flow, and overall
financial resilience. The current study delves into contingent liabilities, explores the accounting
principles, discusses the classification, and examines their impact on decision-making processes.
What is a Contingent Liability?
Contingent liabilities refer to prospective financial obligations or losses that rely on the
result of an unpredictable event. US GAAP from FASB (2023) codification outlined in ASC 450-
20-20 that contingency is a current condition, situation, or scenario with uncertainty about an
entity's potential gain (gain contingency) or loss (loss contingency). The resolution of these
uncertainties depends on the occurrence or non-occurrence of one or more future events.
Moreover, according to FASB Statement No. 5, a contingency is "a current condition,
circumstance, or series of events characterized by uncertainty regarding potential profit or loss
for a company, which will be resolved upon the happening or non-happening of one or more
future events." Instances comprise obligations stemming from legal action, notes receivable with
discounted values, disagreements over income tax, potential penalties resulting from prior
activities, warranty and debts guaranteed by the Company. In contingent liability scenarios, the
Company typically lacks certainty regarding the existence and extent of the liability. For more examples of contingent liability, please see the images below. (Srivastav, 2024)
Principles of Contingent Liability
Anderson Austin (2024) stated in a review published in the Wall Street Journal that,
according to Generally Accepted Accounting Principles (GAAP), contingent liabilities are
recorded based on three accounting principles: full disclosure, prudence, and materiality.
Principle of prudence: It mandates that a company refrain from recording anticipated
gains but must account for expected losses. This safeguards against overstating
income/assets and understating expenses/liabilities.
Principle material states that any items with financial value must be recorded in the
accounting books. Items have financial value if their presence or absence impacts the
business.
Principle Disclosure: It aims to provide users of financial statements with a
comprehensive understanding of the Company's financial position and operating results,
enabling them to make informed decisions.
Classification of Contingent liability GAAP and IFS recognize three categories of contingent liabilities: probable, possible, and remote. However, evaluating a contingent liability in monetary terms can prove difficult, as it is a
liability that could arise contingent upon the outcome of a future event, a probability subject to individual judgment. Given the inherent ambiguity and uncertainty surrounding the amount to allocate for such expenses. It is important to ask two (4) four essential questions before accounting for any potential unforeseen obligation:
If the contingent loss is probable and can be estimated, legal counsel determines the probable standard, which should be greater than 50% (IFRS) or 80% (GAAP). If the contingency meets the 80% occurrence, GAAP requires that the contingency be recorded in the income and balance statements. The journal entries will be debit liability-related expenses and accrue credit liability (Ross,2023).
The entity must disclose this note on the financial statements if the contingent loss is probable or possible and cannot be estimated. The disclosure lets the reader know that there are potential liabilities, but the estimated value is unknown.
If the contingent loss is remote, it is unlikely to occur in Occur. It should not be disclosed.
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Related Questions
The financial position of an enterprise as revealed by its financial statement may be seriously affected by events occurring after the balance sheet date and contingencies. For this reason FRS 21 Events after the Balance Sheet Date and FRS12 provisions, Contingent Liabilities and Contingent Assets lay down rules to ensure that such events and contingencies are properly reflected in financial statements.
Required:
What factors determine whether events after the balance sheet date require adjustment to the financial statements, according to FRS 21 Events after Balance Sheet Date?
Explain the different accounting treatments required for contingent liabilities and contingent assets depending on their degree of probability.
3. Up to what date would it normally be necessary to adjust for or disclose events after the balance sheet date or to disclose contingent liabilities and contingent assets?
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Question 3:-
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https://massygroup.com/wp-content/uploads/2022/11/MASSY-DIGITAL-ANNUAL- REPORT-2022-updated.pdf
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Financial reporting:
Multiple Choice
O
is designed primarily to meet the needs of banks, taxing authorities, and other Governmental regulatory bodies such as the SEC.
O
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is designed primarily for internal planning, control, and decision-making purposes.
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Multiple Choice
To improve internal control over companies' financial reporting.
To add to the work of the companies' external accountants.
To force the companies to disclose more of their internal information.
To provide incentives to increase their net income.
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a. (iv)
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c. (i)
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iii)Evaluation of accounting standards which already in existence.
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a.
i) & iii)
b.
ii) & iv)
c.
iii) & iv)
d.
i) & ii)
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BI U S E :=
A
>
!!!
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Recommended textbooks for you
- Principles of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax College
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Accounting
ISBN:9781947172685
Author:OpenStax
Publisher:OpenStax College