Contingent loss

A contingent loss is one that may arise depending upon whether an event occurs at some point in the future. An analyst looks for documentation of contingent losses in a company's financial statements in order to estimate the probability of additional obligations being incurred by the entity.

If you can reasonably estimate the amount of the contingent loss and it is probable that the loss will occur, then record the loss in the accounting records, which means that it appears in the financial statements. If the loss event is only reasonably possible, do not record the loss in the accounting records; instead, describe the situation in the notes accompanying the financial statements. If the probability of the loss event occurring is remote, it is not necessary to record or describe the event in the financial statement notes.

If the amount associated with a contingent loss is immaterial, it may not be necessary to record the loss, even if the amount can be reasonably estimated and it is probable that the loss will occur.

For example, a company has been notified by the local zoning commission that it must remediate abandoned property on which chemicals had been stored in the past. The company has hired a consulting firm to estimate the cost of remediation, which has been documented at $10 million. Since the amount of the loss has been reasonably estimated and it is probable that the loss will occur, the company can record the $10 million as a contingent loss. If the zoning commission had not indicated the company's liability, it might have been more appropriate to only mention the loss in the disclosures accompanying the financial statements.

The probability of contingent losses should be assessed on a regular basis to see if they have become probable. When a loss probability is classified as probable, create a provision for it in the period in which its probability was restated to the "probable" classification.

It is useful to document why a contingent loss is probable or not, if only to defend the company's position when it is examined as part of an annual audit, or if the company is later subjected to a lawsuit by someone claiming that they should have been informed of a contingent loss.