Question

Blythe Corp. is a defendant in a lawsuit. Blythe's attorneys believe it is reasonably possible that the suit will require Blythe to pay a substantial amount. What is the proper financial statement treatment for this contingency?

Answer 1

US GAAP requires that contingent liabilities (e.g. lawsuits) must be disclosed in the footnotes of the financial statements of Blythe Corporation. If the contingent liability qualifies as probable and a reasonable cost can be estimated, then it must also be reported as a liability in the balance sheet. But since this lawsuit is only reasonably possible, not probable, then it doesn't need to be included in the balance sheet.

As a general thumb rule, we can assume that probable means that the chance of losing is more than 50%, while possible means that there is a 50/50 chance.

Answer 2

The entry is not required because the outcome is reasonably possible, not certain or probable. So IAS 37 says that the liability must not be recognized as the outcome is not reasonably certain or probable.

Step-by-step explanation:

The liability must be included in the financial statement only if the outcome is certain or probable. In this scenario, the outcome is reasonably possible but neither certain nor probable in this situation. So the entry in the financial statement is not required. If the liability is of a huge amount then IAS 37 says that their must be a disclosure in the financial statement notes about the lawsuit.