Contingencies

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.