Chapter 11, Problem 10QS

To determine

Concept Introduction

Contingent Liabilities: Contingent liabilities are the potential obligations that arise due to uncertain future events which are based on (or arises from) past transactions or events. There are mainly three terms of likelihood that are used for the accounting treatment of contingent liabilities. These terms of likelihood are probable, reasonably possible and remote. ‘Virtually certain’ and ‘Remote’ are the two opposite ends of a likelihood scale. The contingent liabilities are treated in three ways in accounting as follows:

a. A contingent liability is recorded in the financial statements if it is probable that a loss (or a future event) will occur and the amount of loss is reasonably estimated. By ‘reasonably estimated’, we mean that the level of certainty of loss will not impair the integrity of the reporting entity’s financial statements.

b. A contingent liability is described in notes to the financial statements if it is reasonably possible that a loss (or a future event) will occur, or if it is probable that a loss (or a future event) will occur but the company cannot reasonably estimate the amount of loss.

c. A contingent liability is neither recorded in the financial statements nor disclosed in notes to the financial statements if the probability (or likelihood) of the occurrence of the loss (or future event) is remote.

To Identify: The accounting treatment for each given claim as either (a) a liability that is recorded or (b) an item described in notes to its financial statements.

Given Info:

The following legal claims exist for Huprey Co.:

1. Huprey is a defendant in a pending lawsuit and estimates that it could result in damages of $1,250,000 and it is reasonably possible (which is a term of likelihood) that the plaintiff will win the case.

2. It is probable (which is a term of likelihood) for Huprey to face a loss on a pending lawsuit will occur but the amount of loss is not reasonably estimable.

3. It is highly probable that Huprey will lose a case and damages in the case are estimated at $3,500,000.