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    Assets, Liabilities, Gains and Losses

    A company is required to report a liability in its balance sheet when it expects to lose a law suit and the amount of the expected loss can be reasonably estimated. Conversely, a company is prohibited from reporting a receivable in its balance sheet when it expects to win a lawsuit even though it is probably and the amount of the expected gain can be reasonably estimated.
    a. Does the expected loss meet the definition of a liability found in the conceptual framework? Explain.
    b. Does the expected gain meet the definition of an asset found in the conceptual framework? Explain.
    c. Why do you think accountants treat these seemingly similar situations differently? Explain.

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    Solution Preview

    Basic objectives of financial reporting:
    Accounting is the means by which information about an enterprise is communicated and, thus, is sometimes called the language of business. Many different users have need for accounting information in order to make important decisions. These users include investors, creditors, management, governmental agencies, labor unions, and others. Investors and other stakeholders in the firm need regular financial information to help them monitor the firm's progress.

    Thus the financial reporting should provide information that is:

    ? Useful to present and potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
    ? Helpful to present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
    ? About economic resources, the claims to those resources, and the changes in them.

    Fundamental qualities

    SFAC No. 2 notes that useful information must have the characteristics of relevance, reliability, and comparability/consistency:

    Primary Qualities
    ? Relevancy -- Information should be timely and bear on the decision-making process by possessing feedback and/or predictive value.
    ? Reliability -- Information must be faithful in representation; free from bias, neutral, and verifiable.

    Secondary Qualities
    ? Comparability -- Even though different companies may use different accounting methods, there is still sufficient ...

    Solution Summary

    The solution looks at financial accounting cases and discusses if a company is liable.