Below are various independent scenarios with respect to a contingent liability a company has at year-end. For each scenario, indicate how the contingent liability should be treated for financial statement purposes. Possible responses are .a. recorded and disclosed, b. disclosed only, and neither c. recorded nor disclosed. The loss is probable and reasonably estimable.

b. disclosed only

Explanation:

A potential liability that may occur in future e.g Pending lawsuits, product warranties etc. It depend on the outcome of a specific future  event. As it is not reasonably measured and presently uncertain, so it is not recorded in the financial statements but it is disclosed in the note to the account to report the matter to stakeholders of the company for their decision making.

The loss is probable and reasonably estimable.

This is a high probability contingent liability.

Explanation:

US GAAP requires that contingent liabilities must be either included in the income statement and balance sheet, only included in the footnotes of the financial statements or not included at all.

US GAAP classifies liabilities as:

High probability contingent liabilities, e.g. warranties, that are almost certain to happen and can be measured properly must be included in the income statement and reported as a liability in the balance sheet.

Medium probability contingent liabilities are those that either are likely to happen (very probable) or can be measured properly. This type of contingent liabilities must not be included in the income statement nor the balance sheet, but must be included in the footnotes.

Low probability contingent liabilities are those that are possible to happen, but not probable, therefore, they should not be included in the footnotes of the financial statements.

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