ACC/541 – Accounting Theory and Research
July 23, 2011
Date:August 6, 2012
The Financial Accounting Standards Board (FASB) defines a contingency as a possible future event that will have some impact on the firm. The decision to report contingencies should be based on the principle of disclosure. Namely, when the disclosure of an event adds to the information content of financial statements, it should be reported. If a potential obligation has a high probability of occurrence, it should be recorded as a liability, although potential obligations with low probabilities are reported in the footnotes to the financial statements (Schroeder, Clark, & Cathey, 2011, p. 369). The primary source accounting rules for contingencies under U.S. GAAP is FASB Statement No. 5, Accounting for Contingencies (FAS 5), which describes two types of contingencies – gain contingencies and loss contingencies. With gain contingencies, they should not be reflected currently in the financial statement because that might result in revenue recognition before realization. However, disclosure should be made of all gain contingencies while exercising due care to avoid misleading implications as to the likelihood of realization. According to the SFAS No. 5, disclose a loss contingency arising from a claim when it is reasonably possible a loss eventually will be incurred; and the loss is either not probable or not subject to reasonable estimation. In the disclosure, indicate the nature of the contingency and give an estimate of the possible loss or range of loss. The disclosure must state if a reasonable estimate of the loss cannot be made. In addition, if the estimate for a loss falls within a range, but only the low end of the range was considered probable and therefore accrued, disclose the range that was not booked. Per the FASB guideline on loss contingencies (ASC 450-20-25-2), if the outcome of the...