Contingencies in Basic Accounting


From an accounting perspective, the term "contingencies" refers to unresolved events — as of the balance sheet date — that could result in a future loss or gain. These events can have various probabilities of actually occurring and even more varied dollar amounts at stake. The Financial Accounting Standards Board has provided a framework for determining how to treat these situations. An understanding of how these guidelines work can keep you in good graces with regulatory authorities.

Probable Losses

Losses considered likely to occur are defined as probable loss contingencies by the Financial Accounting Standards Board. Generally accepted accounting principles require that a probable loss contingency be recorded in the financial statements as a loss of the most likely dollar amount. A disclosure of the loss must be included in the footnotes to the financial statements.

Reasonably Possible Losses

The FASB defines a loss as reasonably possible if its probability is less than likely but more than remote. In this case, a company does not record the loss contingency in the financial statements, but it does disclose a range of potential losses in the footnotes. This is a common treatment for contingent losses related to litigation.

Remote Loss Contingencies

Remote loss contingencies have less than a reasonably possible chance of occurring. Because they're unlikely to occur, these contingencies are not recorded in the financial records, nor are they disclosed in the footnotes of the financial statements. For many companies, lawsuits that are deemed by management to be frivolous are placed in this category.

Gain Contigencies

Gain contingencies are not recorded in the company's books regardless of the probability of occurrence. This treatment is in accordance with the accounting principle of conservatism; companies should record probable expenses and losses and defer the recording of revenues and gains that may not be realizable. The gain contingency may be disclosed in the footnotes, but the company must be careful not to mislead financial users as to the probability of realization. The colloquial rule of thumb here is "Don't count your chickens before they're hatched!"

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