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Financial Accounting and Reporting/Blueprint/3.B

Contingencies and commitments

Area 3: Select Transactions (25-35%)

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Topics

  • Loss contingencies (ASC 450)
  • Gain contingencies
  • Guarantees and commitments

Lessons

  • Contingencies and CommitmentsFree

Study Frameworks

How to Account for a Loss Contingency (ASC 450)

Is it probable that a loss has been incurred as of the balance sheet date?
Yes
Can the amount of the loss be reasonably estimated?
Yes
Is a specific amount within the range a better estimate than any other?
Yes
Accrue the best estimate amount; disclose the contingency
No
Accrue the minimum of the range; disclose the nature and possible additional loss up to the range maximum
No
Do not accrue — disclose the nature of the contingency and state that an estimate cannot be made
No
Is the loss reasonably possible?
Yes
Do not accrue — disclose the nature of the contingency and estimate of possible loss (or state estimate cannot be made)
No
Remote — generally no accrual or disclosure required (except guarantees of others' debt)

Warranty Expense Accrual

Warranty Expense = Units Sold × Estimated Warranty Cost per Unit

Accrue estimated warranty cost in the period of sale (matching principle). DR Warranty Expense, CR Warranty Liability. Reduce liability as claims are paid

Contingency Treatment — Gains vs. Losses

TypeProbable + EstimableReasonably PossibleRemote
Loss contingencyAccrue (debit expense, credit liability) AND discloseDisclose only (nature + estimate of range)No accrual or disclosure (except debt guarantees)
Gain contingencyNEVER accrue — disclose if probableDisclose if materialNo disclosure

Loss Contingency Treatment (ASC 450)

LikelihoodDefinitionAccrue?Disclose?
ProbableLikely to occurYes, if reasonably estimable (minimum of range if no best estimate)Yes — nature and amount
Reasonably possibleMore than remote but less than likelyNoYes — nature and estimate of possible loss or range
RemoteSlight chanceNoGenerally no (except guarantees of others' debt)
PREProbable, Reasonably estimable → Expense (accrue the loss)

The two conditions for accruing a loss contingency under ASC 450. Both must be met: the loss must be Probable AND Reasonably Estimable. If either condition is not met, disclosure may still be required but no accrual is recorded.

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