According to SFAS No. 5, only contingencies in which the possible future event may indicate an asset is impaired or a liability has been incurred on the balance sheet date are candidates for accrual or disclosure. For example, if a product is defective and customers who have used the product may take some action, a contingency exists despite the fact that no claims have been asserted.
I read the above example but I am not sure what it means when it says the customers are going to take some action against the company. I thought that if a lawsuit is filed against a company then those losses would be disclosed in the footnotes of the financial statements if the loss is likely to occur. Is that correct? I am not sure what the example means by take some action.
Reference - http://accounting-financial-tax.com/2009/11/accounting-standard-for-contingencies-an-overview/
A contingency exists when the possibility exists that an action will be taken. In this case, the company executives know that at least some portion of the products they produce are defective and that they may have to repair those goods, replace them, or pay damages because of that defect. (In the case of the Ford ...
This solution discusses what a loss contingency is, how it is computed, and why it is reported.