Question

Briefly explain the rules under GAAP for when loss contingencies need to be disclosed, and when they need to be recorded.

Answer 1

Contingent liabilities, liabilities that depend on the outcome of an uncertain event, must pass two thresholds before they can be reported in financial statements. First, it must be possible to estimate the value of the contingent liability. If the value can be estimated, the liability must have greater than a 50% chance of being realized. Qualifying contingent liabilities are recorded as an expense on the income statement and a liability on the balance sheet.

If the contingent loss is remote, meaning it has less than a 50% chance of occurring, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.