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Reporting requirements for contingencies; effect to financial statements

Your client is being sued. You have asked the client's lawyer about the possibility of losing the lawsuit. The client, meanwhile, has asked you to describe what would happen to their financial statements. The client has also informed you that if they lose the lawsuit, they anticipate losing their mortgage and have started talking to their mortgage lender. They want to know if part of their debt is forgiven, or if their mortgage is rewritten, or if their mortgage will be written if they file Chapter 11.

The lawsuit also involves a patent held by the company. The company had acquired a hedge contract against the impairment of the patent. Aside from the recovery of the hedge, the client wants to know how the impairment of the patent will be reflected on the financial statements in the event of losing a lawsuit.

? Conduct research in FASB individually to answer your client's questions.
? Write a memo that is brief but fully explores the issues. Include the following in your memo:

1) Reporting requirements for contingencies and what would happen to the financial statements if the client loses the lawsuit.

Solution Preview

Reporting for Contingencies:

There are three levels or potential risk related to litigation:

Probable (likely)
Reasonably possible (More than remote, less than likely)

If the loss is probable and the amount of damage can be reasonably estimated, the liability must be recorded in the financial statements as an accrual. (This means immediate recognition of the expected expenses at the point when they become expected and ...

Solution Summary

This solution of 280 words explains the three levels of potential risk related to litigation and requirements for reporting contingencies.