Final answer:
An insignificant and unlikely liability typically does not need to be disclosed on financial statements unless it could have a material effect if it occurred, in which case a note should be added to the statements. Companies must apply judgment in determining disclosure and remain vigilant about reassessing non-disclosures as circumstances change.
Step-by-step explanation:
A liability that has an unlikely chance of occurring and is insignificant in size should generally not be disclosed on the financial statements. If it is not probable or cannot be reasonably estimated, accounting standards typically allow for such liabilities to be omitted from detailed disclosure. This is because the relevance of such information does not justify the cost of documenting it, and it is not likely to impact the decision-making process of users of financial statements. However, it should be noted that this is not an absolute rule and can depend on the context and cumulative effect of similar liabilities. If the unlikely but significant liability could have a material impact if it did occur, a different approach should be taken. In such cases, the guidelines for accounting suggest that a note should be added to the financial statements to ensure users are informed of potential risks, no matter how unlikely.
This approach aligns with the principle of full disclosure, balancing the need for relevance and materiality against the cost and likelihood of the occurrence. In any case, while deciding if a disclosure should be made, entities must consider the possible effect on their financial position and the interest of the users of the financial statements. Applying judgment is necessary, and if the entity decides not to disclose the insignificant liability, it should still monitor the circumstances and reassess the decision if they change.