Criteria for Contingencies

Criteria for disclosing contingencies and why it is important to do so

Contingencies: An existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.

Gain contingencies are not recorded until resolved under certain circumstances such contingencies may be disclosed in the notes to the financial statements.

Loss contingencies have three types of likelihood the liability exists;

* Probable – confirming event is likely to occur.

* Reasonably possible – the chance that a confirming event will occur is more than remote but less than likely.

* Remote – The chance the confirming even will occur is slight.

Criteria for recording loss contingencies

* It is probable that the liability has been incurred at the balance sheet date, and

* The loss is reasonably estimated.

Criteria for disclosing loss contingencies

* If it is reasonably possible that a liability has been incurred at the balance sheet date, and

* The loss is reasonably estimated.

SFAS 5 “Requires that a contingent loss be accrued when it is probable that, at a balance sheet date, an asset is overstated or a liability has been incurred and the amount of the loss can be reasonably estimated. If both conditions are not met but the probability of the loss is at least reasonably possible, the amount of the loss must be disclosed. This loss is reasonably possible and reasonably estimable. Hence, it should be disclosed but note accrued”.

Reporting contingencies allow the users of the financial statements to question their investment or the possibility of future investment based on the likely outcome of the contingency.

Depending on what information is known or unknown, will the contingency be recorded? Footnotes are required in any case if the amount is material and will have a significant impact on the financial results of the...