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Gain Contingencies
Depending upon future events there is a possible chance of receiving assets or reducing liabilities
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Companies usually only record tax loss carryforwards and not possible receipts of monies (gifts, donations, bonuses), possible refunds from the gov't in tax disputes and Pending court cases w/ a probable favorable outcome... why?
Conservative, so they will only disclose gain contingencies in notes only when a high probability exists for realizing them...unusual to find in financial statements.
pg. 651
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Loss Contingencies
Possible losses
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Contingent Liability
A liability incurred as a result of a loss contingency.
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Companies should accrue an est. loss from a loss contingency by a charge to expense and a liability only if the following conditions are met.
1. Probable that it incurred a liability prior to issuance of financial statements
2. The company needs to be able to reasonably determine an amt for the liability. Either through its own experience, experience of other companies in the industry, engineering or research studies, legal advice, or educated guesses by qualified personnel.
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estimated loss contingency should be charged to which accounts?
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What are some common loss contingencies?
1. Litigation, claims, and assessments
2. Guarantee and warranty costs.
3. Premiums and coupons
4. Environmental liabilities
pg. 653
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Recording litigation : What must you consider to report a loss and liability?
Reporting a loss and a liability
1. Time Period: the cause for litigation must have occurred on or before the date of the financial statements.
2. Evaluate the probability of an unfavorable outcome: consider the nature of the litigation, progress of the case, the opinion of legal counsel/ its own and others' experience in similar cases/ and any mgmt response to the lawsuit.
3. Reasonable Estimate of the amt.
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Unfiled suits and unasserted claims and assessments: what must you consider to report a loss and liability?
1. Probability.. that claim may be filed or assessment may be asserted.
2. Probability of unfavorable outcome
3. Loss is reasonably estimable
4. cause for action is dated on or before the date of the financial statements.
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Define warranty
Product guarantee - promise made by a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product.
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When does a company record warranty loss contingency?
If they can reasonably est. liability which include costs that the company will incur after sale and delivery
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There are to Methods to record Warranty Loss Contingency. What are the methods and when do you use it?
1. Cash Basis - Expense warranty costs as incurred. A company must use this method when it does not accrue a warranty liability in the year of sale - cuz liability not probable and reasonable est. of amt cannot be made. Ex: costs are immaterial , warranty period is relatively short.
- 2. Accrual Basis - (GAAP) Charge warranty costs to operating expense in the YEAR OF SALE.
- -Expense Warranty Approach
- -Sales Warranty Approach
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Expense Warranty Approach - Recognition of Warranty Expense Incurred and accrued
- Warranty Expense - D
- Cash, Inventory, Accrued Payroll - C
- (Warranty Costs Incurred)
- Warranty Expense - D
- Liability under Warranties - C
- (To accrue est. warranty costs)
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Expense Warranty Approach: Recognition of warranty costs incurred in 2011 (on 2010 machinery sales) - accrued --> incurred
- Liabilities under Warranties - D
- Cash, Inventory, Accrued Payroll - C
- (Warranty costs Incurred)
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Sales Warranty Approach
Defer revenue on the sale of the extended warranty and generally recognize it on a straight-line basis over the life of the contract.
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Sales Warranty Approach: Recognize sale with original warranty and sale of extended warranty
- Cash - D
- Sales - C
- Unearned Warranty Revenue - C
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Sales Warranty Approach: Recognize extended warranty incurred using straight-line.
- Unearned Warranty Revenue - D
- Warranty Revenue - C
(If extended warranty was sold for $600 and lasted 3 years than the first year would be $200)
pg. 657
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