Commitment
1. Define a “commitment” and explain the method by which it is reported.
2. Define a “contingency” and explain the method by which it is reported.
3. Identify the criteria that establish the reporting of a contingent loss.
4. Describe the appropriate accounting for those contingent losses that do not qualify for recognition at the present time.
5. Explain the handling of a loss that ultimately proves to be different from the originally estimated and recorded balance.
6. Provide the proper reporting rules for a contingency.
Question: The December 31, 2008, balance sheet for E. I. du Pont de Nemours and Company (better known
as DuPont) shows total liabilities of approximately $28.7 billion. Immediately following the liability section,
a separate category titled “Commitments and Contingent Liabilities” is included but no monetary figure is
presented. Note 19 to the financial statements provides further details. In several pages of explanatory material,
a number of future matters facing the company are described such as product warranties, environmental actions,
litigation, and purchase commitments. In financial reporting, what is meant by the terms “commitments” and
“contingencies” (including loss and gain contingencies)?
Answer:
Commitments. Commitments represent unexecuted contracts. For example, assume that a business places an order
with a truck company for the purchase of a large truck. The business has made a commitment to pay for this new
vehicle but only after it has been delivered. Although cash may be needed in the future, no event (delivery of the
truck) has yet created a present obligation. There is not yet a liability to report; no journal entry is appropriate.
The information is still of importance to decision makers because future cash payments will be required.
However, events have not reached the point where all the characteristics of a liability are present. Thus, extensive
information about commitments is included in the notes to financial statements but no amounts are reported on
either the income statement or the balance sheet. With a commitment, a step has been taken that will likely lead
to a liability.