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ABC Advisors is being sued by a former customer. ABC’s lawyers say that it is possible, but not probable, that the company will lose the lawsuit and the trial should last approximately 18 more months. Should ABC lose, they will most likely have to pay approximately $750,000. How should this lawsuit be reported in the financial statements?
a. Current liability of $750,000 and Expense of $750,000.
b. Long-term liability of $750,000 and Expense of $750,000.
c. No disclosure is required.
d. No effect on the balance sheet or income statement, but described in the footnotes.
Concept introduction:
Liabilities:
Liabilities are the obligation of the business or amount payable by the business. Liabilities can current or long term. Current liabilities are liabilities payable within the short term or business cycle of the company, for example Accounts payable for purchases and utilities payable. Long term liabilities are liabilities payable in a long period/ years, for example long term loan.
A contingent liability is a future liability that is dependent upon happening or not happening of an uncertain future event. For example: Amount to be paid if the case running in the court is lost.
A contingent liability is recognized as a liability when it is probable and its reasonable amount can estimate. For example: Amount to be paid the company knows it has lost the case
To choose:
The correct option for recording the given contingent liability.
Explanation for correct answer:
The give contingent liability is not probable so there shall be no effect on the balance sheet or income statement, but it shall be described in the footnote. Hence the correct option is d.
Explanation for incorrect answers:
a...
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