Item B. Contingent LiabilityFacts: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: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?

A contingent liability is referred to as the liability which can be arise based on the outcome of a future event which is unknown. A contingent liability is recorded in the financial statement when the following two conditions are met: It is estimated that the future event will result in a loss. The amount of loss is known. In the given situation, the amount of loss is known which is $5,000,000 but the future event may or may not occur. It is not sure that the future event will occur. Therefore, the company should not record $5,000,000 in the financial statements of 12/31/2020. Instead, the company should disclose the amount in the footnotes to the financial statement as a contingent liability.

Answered: Item B. Contingent Liability Facts:…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

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Item B. 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:

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?

Definition Definition Costs that a business is responsible for paying, should a particular event potentially occur in the future. Also called a potential liability, a contingent liability is generally recorded only when the amount of liability can be reasonably estimated and the contingency is likely to occur shortly. The Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Principles (IFRS) make it mandatory for the companies to record any contingent liability taking the principles of full disclosure, materiality, and prudence into consideration.

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