September 24, 2012
Response to Client Request II
As requested, the accounting team has analyzed the client’s situation to determine the impact this lawsuit will have. While the team waits for the client’s attorney to assess the likelihood of a loss in this lawsuit, the team has provided a thorough analysis of what would happen if the lawsuit is lost. This analysis includes how the accounting team will need to account for the contingency and how that will change if the client loses the lawsuit, affecting the client’s ability to pay the mortgage debt and impairment of the patent.
In 1975, the Financial Accounting Standards Board published Statement of Financial Accounting Standard No. 5, Accounting for Contingencies. SFAS No. 5 defines a contingency as “an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur” (FASB, 450-10-20). A pending lawsuit is an example of a contingency and should be accounted for in the financial statements as outlined in SFAS No. 5.
Before reporting a loss contingency, the client must determine if a loss from the lawsuit is probable, reasonably probable, or remote. If the loss is remote, the contingency will not be reported in the financial statements. If the loss is reasonably probable, the contingency will be disclosed in the footnotes of the financial statements. Disclosure in the financial statements, according to FASB 450-20-50, includes “the nature of the contingency” and “an estimate of the possible loss or range of loss or a statement that such an estimate cannot be made.” If the loss is probable (likely to occur), the circumstances surrounding the lawsuit are reviewed to determine the recognition...