Question

A company is required to report a liability in its balance sheet when it expects to lose a law suit and the amount of the expected loss can be reasonably estimated. Conversely, a company is prohibited from reporting a receivable in its balance sheet when it expects to win a lawsuit even though it is probably and the amount of the expected gain can be reasonably estimated.

Required:

Does the expected loss meet the definition of a liability found in the conceptual framework? Explain.

Does the expected gain meet the definition of an asset found in the conceptual framework? Explain.

Why do you think accountants treat these seemingly similar situations differently? Explain.

Answer 1

As per principle of conservatism, anticipate no profits but anticipate every loss.Since uncertainty is attached to future events,profits are not anticipated but recognised only when realised.But provision is made for all known liabilities and losses.

1.since company is expected to loss a law suit and the amount of loss can be reasonably estimated provision has to be made and shall be shown as a footnote to the balance sheet.

2.As per principle of conservatism , no profits shall be recognised even though amount of gain can be reasonably expected.

Both expected loss and excepted gain does not meet the definition of liability and asset found in the conceptual framework.

As per principle of conservatism and accrual policy accountant shall treat both the items differently.