F4 - M2 - Commitments & Contingencies

Question 1

How should gain contingencies be recorded in the financials statements and disclosure notes at year end?

Answer 1

Gain contingencies should not be recorded (no journal entry) in the financial statements at year-end. Instead, they are disclosed in the notes to the financial statements unless the probability of realization is remote.

• No accrual of gain contingencies due to conservatism.
• Disclosure is required to inform users but avoid recognizing uncertain gains prematurely.
• If the gain contingency is remote, no disclosure is needed.

This aligns with the general rule that only probable and reasonably estimable loss contingencies are accrued, while gain contingencies are disclosed but not recognized until realized.

Question 2

When should a loss contingency be accrued as a liability? What language indicates it should NOT be accrued?

Answer 2

Accrue if the loss is probable (likely to occur) and the amount can be reasonably estimated.

Do NOT accrue if the loss is described as reasonably possible (more than remote but less than likely) or remote (slight chance). Instead, disclose if reasonably possible; ignore if remote (except DOG guarantees).

Common exam language meaning no accrual:
- “Reasonably possible”
- “May occur”
- “Could happen”
- “Less likely than probable”
- “Remote” (usually no disclosure either)

Question 3

What does “probable” mean in the context of loss contingencies, and what action is required?

Answer 3

Probable means the future event is likely to occur (more than 50% chance).

Action: Accrue the loss by recording a journal entry if the amount can be reasonably estimated. If the amount cannot be reasonably estimated, disclose the contingency in the notes.

Question 4

What is the accounting treatment if a loss is reasonably possible?

Answer 4

No accrual; only footnote disclosure is required.

Question 5

How would the exam categorize the following terms into either Probable or Reasonably possible?

“less than likely but more than remote”
“more likely than not”
“likely
“very likely”
“could happen”
“may occur”

Answer 5

Probable = “likely,” “very likely,” “more likely than not”

Reasonably possible = “could happen,” “may occur,” “less than likely but more than remote”

Question 6

What should be included in the footnote disclosure for a reasonably possible loss?

Answer 6

The nature of the contingency, the range of possible loss, and the best estimate if available.

Question 7

What is the treatment for a remote loss contingency?

Answer 7

No accrual and no disclosure, except for certain guarantees (DOG guarantees).