CPA Financial Accounting and Reporting (FAR) : Contingencies
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Example Questions
Example Question #1 : Current Liabilities
Company A has a contingent loss. At the end of Year 1, several possible losses and their probabilities are estimated, including a $130,000 loss (35% chance), $180,000 loss (55% chance), or $80,000 (10% chance). The company also believes it is reasonably possible that the loss could be as high as $230,000. In Year 2, the loss is settled for $172,000. What income statement effect will the company recognize in Year 2?
$8,000 recovery
$15,000 loss
$10,000 recovery
$68,000 recovery
$8,000 recovery
In Year 1, the company will record a contingent loss of $180K, because this is the most likely loss at a 55% chance. In Year 2, then company will need to adjust the liability to reflect the actual loss of $172K, recording an $8K recovery of cost.
Example Question #2 : Current Liabilities
Doe Corp has guaranteed the indebtedness of Rae Corp. Doe can reasonably estimate a loss on this debt ranging from $100,000 to $150,000. Which of the following statements is correct regarding the contingent liability recorded for this debt?
If no estimated amount is more certain than any other, no loss should be recorded
If no estimated amount is more certain than any other, the average possible loss should be recorded
If no estimated amount is more certain than any other, the maximum possible loss should be recorded
If no estimated amount is more certain than any other, the smallest possible loss should be recorded
If no estimated amount is more certain than any other, the smallest possible loss should be recorded
When recording contingent liabilities, a company should record the most likely loss amount. However, if no amount is more probable than any other, a company records the smallest possible loss.
Example Question #3 : Current Liabilities
Of the following costs, which is associated with exit and disposal activities?
Capital lease termination costs
Costs to relocate employees
Costs associated with the retirement of a fixed asset
Terminated employee benefits
Costs to relocate employees
Relocation costs for employees are related with exit and disposal activities.
Example Question #4 : Current Liabilities
The Truman Company sells 12,500 of microwaves during Year 5. All sales are covered by a warranty through the end of Year 6. Based on past experience, the company expects 4% of microwaves sold to break during Year 6 and expects it will cost $30 to fix each microwave. However, during Year 6, 540 microwaves actually break and they each cost $28 to fix. The company is now preparing comparative financial statements for Years 5 and 6. What amount of warranty expense should be recognized?
$15,120 in Year 5 and $0 in Year 6
$0 in Year 5 and $15,120 in Year 6
$14,500 in Year 5 and $620 in Year 5
$15,000 in Year 5 and $1,120 in Year 6
$15,000 in Year 5 and $1,120 in Year 6
The company will estimate warranty expense in Year 5 based on expectations (12,500 microwaves x 4% x $30 each = $15K in warranty expense). In Year 6, it will record the difference needed to true up the warranty expense to actual cost (remaining 40 microwaves x $28 per microwave = $1,120).
Example Question #5 : Current Liabilities
Of the following, which is not a criteria for recognizing a liability associated with exit or disposal activities?
The existence of a present obligation to transfer assets in the future
A commitment to an exit plan
The occurrence of an obligating event
The entity has no discretion to avoid the future transfer of assets
A commitment to an exit plan
An entity's commitment to an exit or disposal plan is not enough to result in liability recognition.
Example Question #6 : Current Liabilities
Which terms indicate that a contingent liability likely should be recognized?
Both
Neither
Probable
Estimable
Both
Both of these terms indicate that a contingent liability must be recognized. Estimable indicates a number available for disclosure and probable indicates that the event will likely occur.
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