Understanding the GAAP requirements
Under Accounting Standards Codification (ASC) Topic 450, Contingencies, a company is required to classify contingent losses under the following categories:
Remote. If a contingent loss is remote, the chances that a loss will occur are slight. No disclosure or accrual is usually required for remote contingencies.
Probable. If a contingent loss is probable, it’s likely to occur and the company must record an accrual on the balance sheet and a loss on the income statement if the amount (or a range of amounts) can be reasonably estimated. Otherwise, the company should disclose the nature of the contingency and explain why the amount can’t be estimated. In general, there should be enough disclosure about a probable contingency so the disclosure’s reader can understand its magnitude.
Reasonably possible. If a contingent loss is reasonably possible, it falls somewhere between remote and probable. Here, the company must disclose it but doesn’t need to record an accrual. The disclosure should include an estimate of the amount (or the range of amounts) of the contingent loss or an explanation of why it can’t be estimated.
Making judgment calls
Determining the appropriate classification for a contingent loss requires judgment. It’s important to consider all scenarios and document your analysis of the classification.
In today’s volatile marketplace, conditions can unexpectedly change. You should re-evaluate contingencies each reporting period to determine whether your previous classification remains appropriate. For example, a remote contingent loss may become probable during the reporting period — or you might have additional information about a reasonably possible or probable contingent loss to be able to report an accrual (or update a previous estimate).
Outside expertise
Ultimately, management decides how to classify contingent liabilities. But external auditors will assess the company’s existing classifications and accruals to determine whether they seem appropriate. They’ll also look out for new contingencies that aren’t yet recorded. During fieldwork, your auditors may ask for supporting documentation and recommend adjustments to estimates and disclosures, if necessary, based on current market conditions. Contact us for more information.
© 2022
Achieving the right balance of working capital
/in Tax/by KKB CPAsDo you know the three keys to lowering your company’s working capital requirements? Continue Reading Achieving the right balance of working capital
Questions you may still have after filing your tax return
/in Tax/by KKB CPAsEven if you filed your 2022 tax return by the deadline, you may still have questions. We’re often asked about refund status, how long to keep records and when an amended tax return should be filed. Here are some answers. Continue Reading Questions you may still have after filing your tax return
4 ways corporate business owners can help ensure their compensation is “reasonable”
/in Tax/by KKB CPAsC corporation owners: To keep your compensation tax deductible, you need to ensure it’s “reasonable.” Otherwise, it could be deemed a dividend. Here are four steps to take. Continue Reading 4 ways corporate business owners can help ensure their compensation is “reasonable”