Question

Contingent Liability

Facts:

• You are auditing a very successful and highly profitable manufacturing company as of December 31, 2020.

• The Company has always maintained adequate insurance in different areas. The Company has decided, effective January 1, 2021, not to purchase insurance against risk of loss that may result from injury to others, damage to the property of others, or interruption of its business operations.

• The Company would like to record a $5,000,000 reserve as of December 31, 2020 for claims associated with future events which may occur.

Required:

1. Should the Company record this $5,000,000 Reserve for Claims (a contingent liability) in its 12/31/2020 Financial Statements? Why or why not?

Answer 1

The term Contingent liability depends on occurence or non occurrence of uncertain future events.

Conditions for disclouser of contingent liability :

1. There should be present obligation arises out of past events but same as not recognised as provision : in this case no present obligation as a result of past events.

2. It is not probable that an outflow of resource embodying economic benefit will be required to settle the obligation : which means how much amount required to pay settle the obligation canot measure with certanity beacuse of non happening of event.

3.The possibility of outflow is also remote : beacuse it depends on future event.

4. Amount of obligation cannot measure with sufficent reliability to recognise them as provision : to recognise a provision their should be sufficent reliability in measuring amount of provision.

Conclusion : Basis above, in our case accident will occur in the future which means if there is future event not past events.The first condition of disclosing a contingent liability is not satisfied and no company should not recognise a contingent laibility