LO9-3 Define contingent liabilities and explain how they are reported in financial statements.

False

A contingent liability is an actual obligation arising from a past event. This statement is

True or False

Recognize a liability and an expense in its financial statements

Standard Company has a contingent liability that has a likelihood of actual occurrence that is classified as probable. Also, the amount of the liability can be reasonably estimated. Under these circumstances, Standard is required to:

Multiple Choice

• recognize a liability only.

• recognize an expense only.

• disclose but not recognize the liability or the expense.

• recognize a liability and an expense in its financial statements.

All of the answers describe classifications of contingent liabilities

According to GAAP, a contingent liability can be classified as:

Multiple Choice

• probable and estimable.

• reasonably possible, or probable but not estimable.

• remote.

• All of the answers describe classifications of contingent liabilities.

True

A company is not required to recognize or disclose a contingent liability that has a remote chance of actually occurring. This statement is

True or False

Recognizing a contingent liability that has a probable chance of occurring and is estimable

Homeland Security Systems experienced an event that had the following effects on its financial statements. The letters “NA” indicate that the component of the equation is “Not Affected”.

Balance Sheet					Income Statement					Statement of Cash Flows
Assets	=	Liabilities	+	Equity	Revenues	−	Expenses	=	Net Income
NA		+		−	NA		+		−	NA

Which of the following events would have caused these effects?

Multiple Choice

• Recognizing a contingent liability that has a remote chance of occurring

• Recognizing a contingent liability that has a probable chance of occurring and is estimable

• Recognizing a contingent liability that has a reasonably possible chance of occurring but is not estimable

• All of the answers describe events that could have caused the effects shown in the financial statements model.

require PhilCo to recognize a $1,000,000 contingent liability but does not permit GreyCo to recognize a $1,000,000 contingent asset.

GreyCo has initiated a lawsuit against PhilCo for a copyright violation. Negotiations between the lawyers representing the two companies suggest that it is probable that GreyCo will win the case and will collect a $1,000,000 settlement fee. Generally Accepted Accounting Principles (GAAP):

Multiple Choice

• require only PhilCo to disclose the suit but does not require the company to show the amount of the settlement as a liability.

• require PhilCo to recognize a $1,000,000 contingent liability but does not permit GreyCo to recognize a $1,000,000 contingent asset.

• require PhilCo to recognize a $1,000,000 contingent liability and GreyCo to recognize a $1,000,000 contingent asset.

• require neither PhilCo nor GreyCo to disclose this information in their financial statements.