Final answer:
A disclosure of a contingent liability is made in the footnotes instead of adjusting financial statement accounts when the outcome is considered reasonably possible, but the potential loss cannot be reasonably estimated, following accounting standards for reporting uncertainties.
Step-by-step explanation:
A disclosure of a contingent liability in the footnotes is made rather than adjusting the financial statement accounts when the outcome of the event is judged to be reasonably possible but the loss cannot be reasonably estimated. This happens when there is uncertainty about certain future events occurring and the financial impact, if they do occur, cannot be precisely quantified.
This is because accounting standards require that for a liability to be recorded on the financial statements, there must be both a probable future outflow of economic benefits and a way to reliably estimate the loss. If only one of these conditions is met, or if the outcome is considered possible but not probable, or if the amount of the potential loss can't be reasonably estimated, then a footnote disclosure is necessary to inform users of the financial statements about the contingent liability and the situation's inherent uncertainty.
For example, if a company is involved in litigation and it is possible but not probable that they will lose the case, and the amount of the potential loss cannot be readily estimated, the company would disclose this in the footnotes. This helps users of the financial statements assess the risk and potential future impact on the company's financial position.
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