IFRS and US GAAP have many subtle differences when accounting for provisions (loss contingencies) for legal claims. An example might be a hazardous waste spill that will require a large outlay to clean up. It is probable that funds will be spent and the amount can likely be how to record a contingent liability estimated. If the estimated loss can only be defined as a range of outcomes, the U.S. approach generally results in recording the low end of the range. International accounting standards focus on recording a liability at the midpoint of the estimated unfavorable outcomes.
However, if there is more than a 50% chance of winning the case, according to the prudence principle, no benefits would be recorded on the books of accounts. If a court is likely to rule in favor of the plaintiff, whether because there is strong evidence of wrongdoing or some other factor, the company should report a contingent liability equal to probable damages. Contingent liabilities are liabilities that https://www.bookstime.com/articles/percentage-of-completion-method depend on the outcome of an uncertain event. US GAAP has a disclosure exemption for unasserted claims if certain criteria are met, but in any event the disclosures under ASC 450 are less detailed than IFRS. Differences between IFRS and US GAAP become apparent when applying the measurement principle. Sometimes a contingent liability can arise suddenly, catching both management and investors by surprise.
What is the journal entry to record a contingent liability?
This principle plays an important role in ensuring reduced information asymmetry between the shareholders and the management. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
These liabilities are categorized as being likely to occur and estimable, likely to occur but not estimable, or not likely to occur. Generally accepted accounting principles (GAAP) require contingent liabilities that can be estimated and are more likely to occur to be recorded in a company’s financial statements. In another case, if the future cost is remote (i.e. unlikely to occur), the company doesn’t need to make journal entry nor disclose contingent liability at all.
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Estimating the costs of litigation or any liabilities resulting from legal action should be carefully noted. Any probable contingency needs to be reflected in the financial statements—no exceptions. Possible contingencies—those that are neither probable nor remote—should be disclosed in the footnotes of the financial statements. It is unlikely that a contingency related to a legal claim would meet these criteria. This contrasts with US GAAP, which has a number of Codification topics that, in combination, cover the same overall scope as IAS 37.
- The company sets an accounting entry to debit (increase) legal expenses for $5 million and credit (raise) accrued expenses for $5 million on the balance sheet because the liability is probable and simple to estimate.
- A contingent liability is an existing condition or set of circumstances involving uncertainty regarding possible business loss, according to guidelines from the Financial Accounting Standards Board (FASB).
- In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the « Deloitte » name in the United States and their respective affiliates.
- These liabilities must be disclosed in the footnotes of the financial statements if either of two criteria are true.