Unformatted text preview: __ r7— Businesses use judgment in determining whether the two criteria are met. To
ecome liable, entities use past experience assess the likelihood that they will b and consult their attorneys. For example, Merck last in three of six Vioxx cases to date, and it may use this information to determine the probability that it will be
to the amount of the liability, busi- held accountable in future suits. To estima nesses use historical data adjusted for new information. Again, Merck might esti- mate the amount of its potential future liability by examining the dollar amount of the judgments in the suits it lost. In the case of a contingency for a cosigned
bility can more easily be estimated as the amount of note, the amount of the lie
the note principal plus interest.
vides contingent liabilities into three categories The accounting profession di
according to each category’s likelihood that the contingency will cause a loss, and
therefore, a liability. The three categories of contingent liabilities, along with how to report them, are shown in Exhibit 11-2. Exhibit 11-2 Three Categories of Contingent Liabilities likelihood That the Contingency How to Report the Contingency Will Become an Actual Liability 3.3mm Ignore. _ 1 '
Example: A frivolous lawsuit. A Reuseuabiy possible Describe the situationin 'a footnote to accompany the ﬁnancial statements.
Example: The company is. the'defundant in a signiﬁcant lawsuit and
the outcomeoould. go'eithar way. ' g Probable, and the amount Record an expense and a liability based on estimated. amounts.
of the loss can be estimated Example: The company is the defendant in a signiﬁcant lawsuit;
legalcounsel believes the outcome will be unfavorable to the-company. Exhibit 11—3 summarizes the transactions that affect various liability accounts. Exhibit 1 1-3 Transactions Affecting Liabiiiy Accounts Liability Account Whent'o Decrease-the Liability ; Pay on account Accounts Mamie Short-Term Notes Payable Pay note continued..... ...
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- Spring '11