A pharmaceutical company faces a class-action lawsuit. Counsel says a loss is probable, somewhere between $10M and $40M, with no point more likely than another. The controller must decide what hits the books and what hits the footnotes, and the answer is not the midpoint.
ASC 450 governs loss and gain contingencies. ASC 460 covers guarantees. ASC 855 governs subsequent events that confirm or refine year-end contingencies. The exam tests these together: likelihood + estimability drive the accounting.
Conservatism drives the asymmetry. A potential loss meeting two thresholds gets booked. A potential gain at the same likelihood waits until realized.
HIGH-FREQUENCY: A loss contingency is an existing condition involving uncertainty as to a possible loss. Classic examples: pending litigation, product warranties, environmental remediation, unasserted claims.
ASC 450 sorts the likelihood of an unfavorable outcome into three buckets:
- Probable: the future event is likely to occur.
- Reasonably possible: more than remote but less than likely.
- Remote: the chance of occurrence is slight.
Common mistakes
- Accruing the maximum of a probable loss range. Range 5M, no best estimate = accrue 5M. The $5M figure belongs in the footnote, not on the balance sheet.
- Using the midpoint when there is no best estimate. Range 5M does not mean accrue $3.5M. The minimum is the floor in the absence of a best estimate within the range.
- Accruing a probable but not estimable loss. ASC 450 requires both criteria. "Probable but cannot estimate" = disclose only, no journal entry. Recording any specific dollar amount is wrong.
Bottom line
- Loss contingency: accrue when probable AND reasonably estimable. Otherwise disclose or do nothing.
- Range with no best estimate: accrue the minimum, disclose the maximum exposure.
- Gain contingencies are never accrued. Disclose only when probable.
- Guarantees (ASC 460): always recognize at fair value at inception, regardless of likelihood.
Exam shortcut
When a stem mentions a probable loss with a range and no best estimate, the trap answer is the maximum or the midpoint; accrue the minimum. When the stem mentions a gain that is "virtually certain," the trap answer is the journal entry; gains are never accrued. PEA test: Probable? Estimable? Accrue. Both must pass.
The full lesson (about 2,334 words, 16 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- III.B1
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