Contingencies. A contingency poses a different reporting quandary. A past event has occurred but the amount of
the present obligation (if any) cannot yet be determined. With a contingency, the uncertainty is about the outcome
of an action that has already taken place. The accountant is not a fortune teller who can predict the future. For
example, assume Wysocki Corporation commits an act that is detrimental to the environment so that the federal
government files a lawsuit for damages. The original action against the environment is the past event that creates
the contingency. However, both the chance of losing the suit and the possible amount of any penalties might not
be known definitively for several years. What, if anything, should be recognized in the interim?
Because companies prefer to avoid (or at least minimize) the recognition of losses and liabilities, it is not
surprising that structured guidelines are needed for reporting contingencies. Otherwise, few if any contingencies
would ever be reported. U.S. GAAP in this area was established in 1975 when FASB issued its Statement Number
Five, “Accounting for Contingencies.” This pronouncement requires the recognition of a loss contingency if
1. the loss is deemed to be probable, and
2. the amount of loss can be reasonably estimated.
When both of these criteria are met, the expected impact of the loss contingency is recorded. To illustrate, assume
that the lawsuit above was filed in Year One. Wysocki officials assess the situation. They believe that a loss is
probable and that $800,000 is a reasonable estimation of the amount that will eventually have to be paid as a
result of the damage done to the environment. Although this amount is only an estimate and the case has not been
finalized, this contingency must be recognized.