[Demha]

FASB Statement #5, Accounting for Contingencies

Scenario: A hospital has been charged with negligence in the death of a patient. Although no claim has yet been filed, past experience indicates that the hospital is almost certain to get sued.

Standard says: The hospital should accrue an estimated loss by a charge to operations as soon as both of the following conditions are met:

(1) It is probable that an asset has been impaired or a liability has been incurred.

(2) The amount of the loss can be reasonably estimated.

*If you can’t meet these conditions then a disclosure of the contingency in the notes will suffice.

Now, I understand it. My question is regarding the fact that what if we can’t estimate and therefore disclose the claim. What are we exactly disclosing? How would you be able to disclose anything without knowing the two conditions? Also, let’s say they got sued and in the end the settlement was $500,000. That would be a huge loss and expense coming out of the current resources. Wouldn’t that misstate the financial statements? I guess in the real world a disclosure would suffice but I think it’s stupid that a disclosure is just good enough for a contingency such as a legal claim. Just wait until the suit reaches a conclusion. Anyway, I just had to get that out of my chest. Now back to studying I go.

Gleim baby!
Grand Valley State University - '15
Accounting & Finance
FAR - 2nd Window '16

[FIFOisbetterthanLIFO]

You disclose based on historical events (it could be the company or industry, etc). Even if you can't estimate the liability with a solid amount, you need to let readers of the financials know that the company may be subject to material (key is material) litigation due to certain circumstances xyz. In the real world, there is wiggle room in the whole contingent liability ordeal. For example, companies don't normally have to disclose lawsuits they believe are frivolous.

In regards to the second part about misstating financials, GAAP is by nature extremely conservative. The better “safe than sorry” attitude comes to mind. It encourages companies to play safe, however, it is not meant to be unreasonable and beat down companies earnings “just in case”.

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[Demha]

Thanks for the thorough response @Fifo

Gleim baby!
Grand Valley State University - '15
Accounting & Finance
FAR - 2nd Window '16

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