Contingent more than likely not going to happen
Contingent Liability 1. Analyze why a company would prefer not to disclose its contingent liabilities. In order to understand why a company would or would not disclose his contingent liabilities it is important to know exactly what a contingent liability is. As I have learned throughout all of my accounting studies a liability is simply an obligation or debt that a business owes to an individual or an organization.
Now there are many liabilities that include services, payroll, notes, and accounts payable.When one of these liabilities becomes a contingent liability it means that it is something that is a potential situation at the time. Contingent liabilities depend on a future event. What this means is the company may or may not have to pay this liability to let something happen resulting for a loss.
There are three types of contingent liabilities and each has its own rules on when and how to report its loss or potential loss on financial statements. The first type of contingent liability is called remote. A remote contingent liability would be something that is more than likely not going to happen or occur.In a situation like this a disclosure is not required nor a journal entry into the financial statements. An example of a remote contingent liability would be a frivolous law lawsuit.
A frivolous lawsuit would be ignored in this situation. The second type of contingent liability would be reasonably possible. When a contingent liability is reasonably possible it means that there is a reasonable possibility that a loss can occur.
A significant lawsuit where the results are not known yet is a good example of a reasonable possible contingent liability.In this situation although the amount cannot be estimated, both the contingent liability and the contingent loss would be disclosed in all financial statements. The third type of contingent liability would be probable.
Probable contingent liability would occur when it’s almost certain that there is going to be liability and loss recorded. An example of probable contingent liability would be warranty company’s products. The company knows that a certain percentage of warranties will be called upon. So in a case like this the company would estimate the amount and go ahead and record both liability and loss.
These funds would then be available when a warrantee needs to be paid out. With a clear understanding of the three different types of contingent liabilities we can now further analyze why a company may or may not disclose this information as we have learned with a remote contingent liability most situations would be the ignored. Neither liabilities nor losses would be recorded or disclosed in any financial statement. When a contingent liability falls in the reasonable possible category or probable category the contingent loss would be disclosed in all financial statements or recorded.If the liability has the potential to cause the company a huge loss the company may not want to disclose this information. For example let’s say a company was going to the bank to ask their loan officer for loan to fix or expand their facility.
A general stipulation of the loan would include the gathering of all financial statements. If the underwriters of the loan discover that there is a potential for a loss that was disclosed as a contingent liability, the bank may not approve the loan. If the company decides not to disclose this particular information then their chances of getting loan would not be jeopardized.Although these are not the best accounting practices I’m sure there are companies out there that have done just like my example above. Outside of the example I provided a company might not want to record their contingent liability simply because it will show a decrease in profits.
Contingent liability is just that, it is contingent on future events. The company’s profits would look a whole lot better if there were no estimated losses subtracted out that bottom line profit. 2. Examine why GAAP requires companies to report contingent liabilities.
amp; 3. Determine what parties and how they could be harmed by non-disclosure. The GAAP (Generally Accepted Accounting Principles) requires companies to report contingent liabilities, arrangements, and any additional obligations that may affect a company’s financial condition. These disclosures should be for the most recent this year and in some cases included any changes or additions from the previous year. The GAAP has required companies to report these contingent liabilities to assist any financial markets that many extend credit to a business.This disclosure is also important for stock and shareholders who are looking at purchasing into a company and even a potential partnership that may develop within a company.
If a new partnership is formed or a new bank obligation is fulfilled in these liabilities were not disclosed it could potentially lead to additional lawsuits. A bank lending money to a business has to right to know if this business has the possibility of losing a large amount of funds in the future. Let’s say the bank lends the company money and the company has a possible contingent liability pending.The company does not disclose this to the bank, and the lawsuit results in a huge loss. The company now does not have the funds to pay for the new loan from the bank. Now we have a company has to pay in the contingent liability and the bank that potentially will be taking loss.
This also applies to a potential partner that wants to join the company they also have the right to know if there is a potential loss in the future. If a company signs on a new partner and does not disclose all the potential liabilities and losses and then the company takes those losses the new partner could lose their capital. . Examine the ethical tightrope companies must walk when they report contingent liabilities. Although it would be very easy for a company to not report the contingent liabilities, it’s not the ethical thing to do.
On one hand every company tries to maximize their profits and make the company look like it’s the best they could possibly be. On the other hand trying to be honest about how your company is really doing and trying to disclose all the proper information can be very difficult. This particular question makes me think of Bernard Madoff and the Etcon Company.I would imagine that somewhere along the Way, Bernie Madoff did not disclose the proper contingent liabilities when it came to his financial statements.
I am also 100% sure that the Etcon company experiences the same ethical decisions and as we all know today both situations did not turn out for the best but if the GAAP says you’ve got to disclose these liabilities then you should disclose these liabilities that’s why they are the general accepted accounting principles. References Horngren, Harrison, Oliver (2010). Accounting Chapters 14 with SupplementMaterial New Jersey: Prentice Hall Averkamp H.
What is a contingent liability? Accounting Coach Retrieved May 7, 2011 from http://blog. accountingcoach. com/contingent-liability-contingency/ Contingent Liability Accounting Tools Retrieved May 7, 2011 from http://www.
accountingtools. com/contingent-liability (November 18, 2002) Sarbanes-Oxley Update: SEC Proposes Rules on Non-GAAP Financial Information and MD;A Disclosure Dorsey: Dorsey ; Whitney LLP Retrieved May 7, 2011 from http://www. dorsey.
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