- A company is involved in litigation. Legal counsel advises that it is probable the company will lose and estimates the loss at between $500,000 and $800,000, with no amount in the range being a better estimate than another. Under ASC 450, what amount should be accrued?
Answer: $500,000
When a loss is probable and a range of loss can be estimated but no amount within the range is a better estimate than another, ASC 450 requires accrual of the minimum amount of the range. Answer A ($500,000) is correct. Answer B (the midpoint) is the IFRS approach under IAS 37 but not U.S. GAAP. Answer C accrues the maximum, which overstates the liability. Answer D is incorrect because a range constitutes a reasonable estimate.
- Under ASC 450, the term 'probable' in the context of loss contingency accrual means:
Answer: The future event is likely to occur.
Under ASC 450, 'probable' means the future event or events are likely to occur - a somewhat higher threshold than 'more likely than not' (>50%) but less than 'virtually certain.' It is generally interpreted as a high likelihood. Answer C is correct. Answer A describes the 'more likely than not' threshold used in other contexts (e.g., tax positions). Answer B is 'virtually certain,' which is too high. Answer D describes 'reasonably possible,' which is the disclosure threshold.
- A company has probable litigation losses with a best estimate of $400,000. The company also has a probable insurance recovery of $150,000 related to the same claim. How should these be presented on the balance sheet under U.S. GAAP?
Answer: Liability of $400,000 and a separate receivable of $150,000, if receipt of the insurance proceeds is probable.
Under U.S. GAAP, the gross liability ($400,000) is recorded separately from any recovery. An insurance recovery receivable may be recognized separately when receipt is probable (ASC 450-20-55-19 / ASC 410). The two cannot be netted on the balance sheet. Answer A is correct. Answer B nets the two amounts, which violates the gross presentation requirement. Answer C is overly conservative - probable insurance recoveries can be recognized. Answer D defers recognition of a probable, estimable loss.
- A company is being sued for patent infringement. The case is complex and ongoing. At year-end, legal counsel is unable to assess the likelihood of an unfavorable outcome. Under ASC 450, how should this be reported?
Answer: Disclose the nature and status of the contingency and state that an estimate of the loss cannot be made.
When the likelihood of loss cannot be assessed, neither accrual nor omission of disclosure is appropriate. ASC 450 requires disclosure of the nature of the contingency and a statement that an estimate cannot be made. Answer D is correct. Answers A and C accrue a liability when the loss is not assessed as probable. Answer B omits required disclosure - even uncertain contingencies of significance require disclosure.
- A lawsuit is filed against a company in December Year 1. At December 31, Year 1, legal counsel believes the likelihood of an unfavorable outcome is remote. How should this be reported?
Answer: No accrual and no disclosure required.
Under ASC 450, remote contingencies generally require neither accrual nor disclosure. When the likelihood is remote, the loss is not accrued and disclosure is not required (with limited exceptions for guarantees). Answer A is correct. Answer B incorrectly requires disclosure for all remote contingencies. Answers C and D require accrual, which is only appropriate when loss is probable and estimable.
- A company guarantees the debt of a subsidiary. The subsidiary is in financial distress and it is probable the parent will have to pay $300,000 under the guarantee. The amount is reasonably estimable. How should the parent account for this?
Answer: Accrue a $300,000 loss contingency liability.
When payment under a guarantee is probable and reasonably estimable, ASC 450 requires accrual of a loss contingency. The parent records a $300,000 liability. Answer C is correct. Answer A incorrectly treats all guarantees as off-balance-sheet. Answer B records an asset rather than a liability - recovery rights may be disclosed but the primary entry is the liability. Answer D reduces the investment account, which is not the correct entry for a guarantee payment obligation.
- A company estimates warranty costs at 2% of annual sales. Sales are $4,000,000. Actual warranty claims paid during the year total $55,000. The beginning warranty liability balance is $30,000. What is the ending warranty liability balance?
Answer: $55,000
Warranty expense accrued = $4,000,000 x 2% = $80,000. Ending balance = $30,000 + $80,000 - $55,000 = $55,000. Answer A is correct. Answer D ($80,000) is beginning balance plus accrual before deducting claims paid. Answer B is the beginning balance unchanged, ignoring both accruals and claims. Answer C results from subtracting claims paid from the beginning balance only, ignoring the current-year accrual.
- Which of the following best describes the appropriate financial statement treatment for these contingencies?
Answer: Accrue Case B at $850,000; disclose Case A as reasonably possible; make no mention of Case C since it is less than 50% likely
Under ASC 450-20, 'probable' is generally interpreted as more likely than not (>50%). Case B at 75% probability meets the probable threshold and should be accrued at the best estimate of $850,000. Case A at 60% also exceeds 50% but the stem provides only a range ($300,000-$500,000) with no indication of the best estimate, so the minimum should be accrued - however, this makes Choice A partially correct. Case C at 45% is reasonably possible and should be disclosed. Choice C is the best answer because it correctly identifies Case B for accrual and properly treats the others. Choice A incorrectly assumes the minimum for Case A when the range requires more analysis. Choice B incorrectly treats 60% as not probable. Choice D incorrectly states an 80% threshold that doesn't exist in GAAP.
- Under ASC 450, which of the following circumstances would require accrual of an environmental remediation liability?
Answer: It is probable that the company is liable and the remediation costs can be reasonably estimated.
Environmental remediation liabilities follow the same ASC 450 accrual criteria: probable and reasonably estimable. Answer C is correct. Regulatory identification (A) alone does not establish probability of company liability. A belief of non-responsibility (B) suggests loss is not probable. Possible but inestimable (D) requires disclosure but not accrual.
- A company has an accrued litigation liability of $500,000 at year-end. New information received before the financial statements are issued indicates the actual settlement will be $200,000. What is the appropriate accounting treatment?
Answer: Reduce the accrual to $200,000; the new information relates to conditions existing at the balance sheet date.
New information received after the balance sheet date but before financial statement issuance that provides evidence of conditions existing at the balance sheet date is a recognized subsequent event under ASC 855. The accrual is adjusted to $200,000. Answer A is correct. Answer B ignores Type I subsequent event guidance. Answer C reverses and defers, creating a period mismatch. Answer D has no basis in GAAP.
- A company operates in a jurisdiction with an environmental cleanup statute. The company knows contamination exists on its property but asserts that cleanup costs cannot be reasonably estimated. Under ASC 450, what is the minimum required treatment?
Answer: Disclose the nature of the contingency and state that a loss amount cannot be estimated, if the loss is at least reasonably possible.
If remediation is at least reasonably possible but cannot be estimated, ASC 450 requires disclosure: nature of the contingency and a statement that the amount cannot be estimated. Answer C is correct. Answer A accrues without a basis for estimation. Answer B defers all action, ignoring disclosure requirements. Answer D records a nominal liability with no GAAP basis.
- Under ASC 450, which of the following is a required disclosure for a loss contingency that is reasonably possible but cannot be reasonably estimated?
Answer: Disclose the nature of the contingency and state that an estimate of the possible loss cannot be made.
For a reasonably possible contingency that cannot be estimated, ASC 450 requires disclosure of the nature of the contingency and a statement that an estimate cannot be made. Answer D is correct. Answer A omits required disclosure. Answer B accrues a nominal amount with no basis in the standard. Answer C discloses only the maximum, which is not a prescribed approach when an estimate cannot be made.
- A contingency that is remote in likelihood but could result in a very large loss is sometimes disclosed voluntarily. Under ASC 450, which of the following most accurately describes required disclosure for remote contingencies?
Answer: Remote contingencies generally need not be disclosed, except for certain guarantees of others' indebtedness.
Under ASC 450, remote contingencies generally do not require disclosure. The primary exception is for guarantees of indebtedness of others - even if the probability of loss is remote, guarantees must be disclosed. Companies may also choose to voluntarily disclose large remote contingencies, but it is not required. Answer D is correct. Answers A, B, and C impose disclosure requirements for remote contingencies beyond what ASC 450 mandates.
- A company is a defendant in a lawsuit. Legal counsel provides the following assessment: 30% chance of no loss, 40% chance of $200,000 loss, 30% chance of $500,000 loss. The loss is deemed probable. Under ASC 450, what amount should be accrued?
Answer: $200,000 (minimum of the estimated range).
Under ASC 450, when a range can be identified and no amount within the range is a better estimate, the minimum of the range is accrued. The range of probable loss is $200,000 to $500,000. The minimum is $200,000. Answer C is correct. Answer A uses expected value (probability-weighted), which is the IFRS approach under IAS 37, not U.S. GAAP. Answer B accrues the maximum. Answer D incorrectly concludes the uncertainty precludes accrual.
- Which of the following is an example of a gain contingency under ASC 450?
Answer: A pending lawsuit in which the company is the plaintiff and may receive $500,000.
A gain contingency is an existing condition involving uncertainty about a possible gain. A lawsuit where the company may receive proceeds is a gain contingency. Answer D is correct. Answer A is an insurance recovery that is probable - under U.S. GAAP this may be accrued as a receivable when receipt is probable (not technically a contingency once probable). Answer B is a loss contingency (warranty liability). Answer C is a loss contingency from a payment obligation.
- Theta Corp was notified in November 2024 that a former employee filed a wrongful termination lawsuit seeking $750,000 in damages. The termination occurred in August 2024. Legal counsel's assessment indicates there is a 70% probability of an unfavorable outcome, with expected damages of $425,000 if the case is lost. However, Theta's insurance policy covers wrongful termination claims with a $50,000 deductible. The insurance company has confirmed coverage and indicated they expect to pay the full amount above the deductible if Theta loses the case. How should Theta account for this matter in its December 31, 2024 financial statements?
Answer: Record a $425,000 loss contingency liability without recognizing the insurance receivable, since gain contingencies should not be recorded until realized
Under ASC 450-20 and 450-30, loss contingencies and gain contingencies (such as insurance recoveries) should be evaluated separately. The loss contingency meets the criteria for accrual (probable and estimable at $425,000), so the full liability should be recorded. However, the insurance recovery is a gain contingency that should not be recorded until virtually certain or realized, even if probable. The insurance recovery may be disclosed in the notes. Choice A incorrectly nets the loss and gain contingencies. Choice B incorrectly records only the net amount. Choice D incorrectly concludes that materiality eliminates the need for accrual when the gross amount is clearly material.
- A company is sued in Year 1. At December 31, Year 1, the loss is probable and estimated at $300,000. By the time the Year 1 financial statements are issued in March Year 2, the lawsuit settles for $350,000. Under ASC 855 (subsequent events), how should the settlement be reflected?
Answer: The Year 1 accrual is adjusted to $350,000 because the settlement provides evidence of conditions existing at December 31, Year 1.
Under ASC 855, a recognized subsequent event provides additional evidence of conditions that existed at the balance sheet date. The settlement of a lawsuit that existed at year-end is a Type I (recognized) subsequent event. The Year 1 accrual is adjusted to $350,000 before issuance. Answer B is correct. Answer A treats the settlement as a non-recognized (Type II) event. Answer C records the additional $50,000 in Year 2. Answer D defers all recognition to Year 2.
- A company accrues a $120,000 loss contingency related to a customer claim in Year 1. In Year 2, the claim is settled for $95,000. What entry records the Year 2 settlement?
Answer: Debit Litigation Liability $120,000; Credit Cash $95,000; Credit Gain on Settlement $25,000.
At settlement, the full liability ($120,000) is removed. Cash paid is $95,000. The $25,000 difference between the liability and the settlement is a gain recognized in Year 2. Entry: Debit Litigation Liability $120,000, Credit Cash $95,000, Credit Gain on Settlement $25,000. Answer B is correct. Answer A records only the cash payment as an expense with no liability reduction. Answer C removes only $95,000 of the liability, leaving a $25,000 balance. Answer D records the difference as an adjustment to the liability without settling it.
- Under ASC 450, which of the following contingencies requires disclosure but NOT accrual?
Answer: A reasonably possible loss that cannot be reasonably estimated.
A reasonably possible loss that cannot be estimated requires disclosure of the nature of the contingency and a statement that an estimate cannot be made - but it is not accrued. Answer B is correct. A probable, estimable loss (A) requires accrual. A remote loss (C) requires neither accrual nor disclosure in most cases. A probable but inestimable loss (D) requires disclosure but also does not meet both accrual criteria - it is disclosed only.
- Under ASC 450, a loss contingency is accrued when which two conditions are both met?
Answer: The loss is probable and the amount can be reasonably estimated.
Under ASC 450-20-25-2, a loss contingency is accrued when (1) it is probable that a liability has been incurred, and (2) the amount can be reasonably estimated. Both conditions must be met. Answer D is correct. Answer A uses 'possible' instead of 'probable.' Answer B requires certainty, which is too high a threshold. Answer C describes the disclosure threshold (reasonably possible), not the accrual threshold.
