When there is a threat that an entity’s assets will expropriated, U.S. accounting guidelines require that the event be treated as a loss contingency. Loss contingencies must meet certain conditions that will determine how they are disclosed for accounting purposes. Amounts for the loss of assets can be accrued and recorded, disclosed by amount and the nature of the loss, or ignored.
Classification of Contingencies
Generally Accepted Accounting Principles classify loss or gain contingencies in one of three possible ways. First, the loss or gain is probable and likely to occur. Second, the loss or gain is reasonably possible, which means it is more than remotely possible but less than probable. Third, the loss or gain is remote.
Probable and Reasonably Estimated Loss
When the threat of asset expropriation is probable and can be reasonably estimated, the amount of the asset loss must be accrued. If certain conditions are met, the loss is charged against income in the period when the loss is probable. Based on the information available as of the date of the financial statements, it is considered probable that an asset has been impaired or a liability incurred. When a range of losses is considered probable, use the best estimate amount of the loss. If none of the amounts are considered a better estimate, accrue the minimum amount in the range and disclose the possible higher amount.
Example of a Probable Loss
For example, a company receives information that a manufacturing plant will be seized by local authorities. In the current accounting period, the amount of the loss is estimated to be $1 million. Record the $1 million loss against current income under the category “Extraordinary Items.” Extraordinary Items are those that are infrequent and unusual in nature.
If the company cannot determine an exact loss but estimates the probable loss is between $1 million and $2 million, the company charges current income under the “Extraordinary Items” category for $1 million and discloses in the notes to the financial statements a possibility that an additional $1 million loss could occur.
Reasonably Possible Loss
If a loss is not probable or reasonably estimated based on the available information, determine if there is a reasonable possibility that a loss has been incurred. If there is a reasonable possibility, disclose the nature of the asset expropriation and disclose the possible loss or range of losses in the notes to the financial statements. If the amount of the loss cannot be estimated, disclose this fact instead.
Usually, a remote possibility of asset expropriation is ignored. There are some exceptions, such as a guarantee to repurchase receivables or other related property that has been sold or assigned. The guarantee should be disclosed in the notes to the financial statements.
- Financial: CPA Exam Review; DeVry/Becker Educational Development Corp.
- Accounting Financial Tax: Accounting Standard for Contingencies [An Overview]