CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A company needs to account for a contingent liability related to an ongoing lawsuit. Legal counsel advises that it is probable that the company will lose the lawsuit, and the estimated loss can be reasonably estimated within a range of $5,000,000 to $10,000,000. There is no amount within the range that is a better estimate than any other amount. How should the company report this contingent liability in its financial statements under U.S. GAAP?
- AAccrue a liability of $10,000,000 and disclose the range in the notes.
- BAccrue a liability of $7,500,000 and disclose the range in the notes.
- CDisclose the contingency in the notes to the financial statements.
- DAccrue a liability of $5,000,000 and disclose the range in the notes.
Show answer & explanationAnswer & explanation
Correct answer: D. Accrue a liability of $5,000,000 and disclose the range in the notes.
Under U.S. GAAP, if a loss is probable and a reasonable estimate can be made, but no single amount within a range is a better estimate than any other, the minimum amount of the range should be accrued. The entire range should be disclosed.
Why the other options are wrong
- A. Accruing the maximum amount is incorrect when no single amount is a better estimate.
- B. Accruing the midpoint is incorrect under U.S. GAAP when no single amount is a better estimate; the minimum is used.
- C. Disclosure only is insufficient when the loss is probable and estimable.
Contingent Liability (GAAP)
A contingent liability is a potential obligation arising from past events, whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity's control.
- Accrued if probable and estimable.
- If a range is estimable and no amount is better, accrue the minimum.
- If a range is estimable and an amount is better, accrue that amount.
Memory trick: PROBABLE & ESTIMABLE? Then ACCRUE, otherwise just DISCLOSE.