Contingent Liabilities

Lesson Exercise Solution

Sometimes things happen during the year that might result in a future liability or gain.

How do we figure out how to record them?

There are three possibilities for liabilities:

Probable AND Reasonably Estimable - Recognize the liability on the balance sheet.
Probable OR Reasonably Estimable - Record the liability on the notes to the financial statement.
Not Probable and Not Reasonably Estimable - Don't recognize or record it.

Fortunately, figuring out what to do with potential future gains is much easier.

Future Gains can not be recognized on the balance sheet, but they can be put into the notes of the financial statements.

When it comes to figuring out which dollar amounts to use, there are a few rules:

If the estimate consists of one number, use that figure.
If there's a range of estimates, but one number is most likely, use that number.
Otherwise, if there's a range of values, and no number is more likely than any other, use the lowest value.

You're a consultant with expertise in financial statements. One of your clients needs your help to determine if and how something should be recorded.

This is what you've been told:

Due to an issue with a rebate offer, the firm is expecting a reasonably possible loss next year, estimated between $364 and $510, with no figure more likely than any other.

How should this be recognized or recorded?

The loss of $364.00 should be recognized on the balance sheet and in the financial notes.

Contingent liabilities that are probable and can be estimated, should always be recognized on the balance sheet and reported in the financial notes.
Since a range for the liability was given, with all numbers equally likely, we should go with the low end. This helps to ensure we won't have to reverse it with a gain if we overestimated the liability.