 Hello, and welcome to this session in which we'll discuss the loss contingency. What is the main idea behind loss contingency? Well, it's a loss. Obviously, it's a loss. It could be also a gain, but we're concerned more with the loss that is based upon an event happening. So the loss is contingent. It means there is a condition that could happen or it may not happen. And when that happen or may not happen for a period of time, it will resolve this uncertainty. The best example of a loss contingency or a gain contingency is a lawsuit slash litigation. If someone sues you, well, guess what? You have to wait until the outcome. See what happened to that outcome. Well, the outcome could be against you. You could have a loss or if you sue someone, you could have a gain or you can be sued and not lose anything. So what's happening is you are waiting for that contingency to resolve itself. Well, while you're waiting, what do we have to do for accounting purposes? In other words, do you record the loss, not record the loss? What do you have to do with this? So as I said, lawsuit is a good example. You are being sued or you are suing someone. Environmental liabilities. You have a cleanup to do. You are responsible because you had, for example, like bridge petroleum. You had a spill. Your oil spill in the Gulf of Mexico. You have a cleanup. Environmental liabilities. Warranty and guarantee costs. And we'll discuss this in a separate recording because it's very important to understand how we account for warranties and guarantees. Because when you guarantee a product, the customers might come back and you have to make them good on that product. You have to fix the product, replace the product. That could be a loss contingency. Coupons. For example, many retailers or many supermarket stores, what they do is they offer coupons to customers. So when, or manufacturers for that matter, what happens is as a customer, you collect those coupons and some customers will go back and would redeem the coupon. So the coupon themselves are a loss contingency. When the customer comes back to redeem them, the company will have to come up with either cash or free product. So that's a loss contingency. Not everyone will come back, but some people will come back. So the company will estimate that contingency rebate. Sometimes you might buy a computer. You might buy a desktop and with it comes a rebate, basically a form. You fill it out. And if you fill it out and you send it back to them, they'll give you $100 off. And I did this long, long time ago. I bought a desktop when, you know, desktops were popular. And I don't remember the price for it, but they gave me $100 rebate. And I never understood why, why would they give me $100? They send me a check for $100. If I fill out this form and send it back to them, well, they want to collect information about you, my address. Well, I bought a computer. It means I like computers. They can sell this information to marketing companies. Also, that guarantees could be a contingent liability. Basically, a loss contingency is when you guarantee the debt of other companies. So one company will guarantee the debt of another company. Why? Because they want them to survive. They want them to be able to borrow money. So therefore they will guarantee the debt. What happen if you guarantee the debt of another company? You are responsible for that debt. If something happens, you are responsible for that debt. So let's assume we do have those situation. What do we have to do? Well, here's what we have to do. First, we have to estimate our probability to determine what accounting treatment we should have. Estimating the probability means what? It means estimating what's the event happening against us or for us. For example, if we are being sued, I will use the lawsuit as an example. And the chance of being us losing is 3% chance. We spoke to the lawyer and the lawyer said, there's nothing to this case. Just you can't forget about it. Well, if that's the case, that could happen. The loss is ignored. We don't do anything if there's a remote chance. The probability is remote. In other words, there is no chance we are going to lose. How do we determine this? Well, we ask expert, lawyers, consultant, people that knows something about the issue. And they told us, look, don't worry about it. It's remote. Now, if the probability is reasonably possible, what is reasonably possible? Well, there's no reasonably possible quantitative number. But let me tell you, I'm just going to put a number for it to understand it. Well, there's a 50% chance we could lose. There's a 50% chance we may not lose. So we really don't know. It's reasonably possible. What do we have to do under those circumstances? Under those circumstances, we have to disclose this information in the footnote. What does that mean? That means in the annual report, in the notes of the financial statements, we have to say, for example, if we are being sued, we would say something to the effect that we are being sued by such and such party in such and such court. And the outcome will come in two years. And just so we will not let you know about this. That's it, reasonably possible you disclose. What happened if the probability is high? Notice I put it in red. What is high? It means there is a 90% chance and there is no numbers in the literature. I'm just making those numbers to illustrate what is high probability. There is a good chance you are going to lose. More likely than not, you are going to lose this case or you are going to come up with the money. Well, if that's the case, what do you have to do? Well, if you don't know the number, if you don't know how much you are going to be responsible for, you just disclose it. You know you are going to lose, but you have no clue whether it's $10 or $10 million. Maybe the judge or the jury will decide and there is no precedent. You just, you cannot really know. Now, if it's probable and notice the plus and you can estimate the dollar amount. Now, you can estimate. You might have more than one estimate. We'll look at an example to see what happened to the estimate. If we have more than one estimate, you might have a low estimate, a low estimate, high estimate. How do you deal with this? Well, if that's the case, if it's probable and you know the dollar amount, under those circumstances, you accrue. What does accrue mean? It means you're going to have to debit some sort of a loss and credit liability. So now you accrue the loss. So when do you accrue the loss? Well, two conditions will have to be there. It's probable you are going to lose and you can estimate the dollar amount. If those two conditions exist, even if you have a range, we're going to look at an example to see how it works. If you have a range of estimate, then you have to accrue. Now, the best way to illustrate this is to look at an example. Before we look at an example, let me just remind you whether you are an accounting student or a CPA candidate to take a look at my website and my resources, farhatlectures.com. I don't replace your CPA review course, nor I replace your accounting course. I'm a useful addition to your CPA review course. I'm a supplement to your accounting courses. I explain the material differently. I provide you with resources, multiple choice, through false additional lectures and exercises that's going to help you understand the material better. Your risk is one month of subscription. Your potential gain is improving your performance, whether it's your accounting class or your CPA review course. If not for anything, take a look at my website to find out how well or not well your university reviewing on the CPA exam. This is a list of all my accounting courses that I have resources for. Advanced accounting, managerial accounting, intermediate, A to Z, all accounting courses. My CPA supplemental resources are aligned with your Becker, Roger, Gleam and Wiley. So it's very easy to go back and forth between my material and your CPA review course. I give you access to 1500 plus previously AI CPA released questions with detailed solution. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter and Reddit. So let's take a look at this example to illustrate the concept. Let's assume British petroleum BP is involved in environmental liability at December 31st, 20x5. So we do have an environmental liability. So prepare the December 31st entry assuming that it's probable and will be liable for 1.5 million. Well, if it's probable and we know the dollar amount, pretty straightforward. We're going to debit the loss, credit the liability for 1.5 million, pretty straightforward. Both of these conditions exist. We book the liability and the loss. Let's assume it's not probable that we will be liable. That means it's reasonably possible or there is a remote chance. What entry do we make? No entry. If it's reasonably possible, we disclose. If it's remote, we don't do anything. And to be safe, always disclose. How about that? Prepare the December 31st entry if any, assuming it's probable that BP will be liable and the amount could be 1,250,000, 1.4 million, I'm missing two zeros here, 1,750,000 or 2 million. And we are told by the lawyer or by the expert, the most likely amount is 1.4 million. Well, good. If we know the most likely amount is 1.4 million, guess what? We're going to go with that estimate. Debit, environmental cleanup loss, 1.4 million, credit liability, 1.4 million. Why? We are giving a range and we are told the most likely amount will go with the most likely amount. Well, let's prepare the December 31st entry if any, assuming that it's probable that BP will be liable and the amount could be 1,250,000, 1.4 million, 1,750,000 or 2 million. Well, now we have four figures and we are not told which one is the most likely amount. What do we do under those circumstances? Under gap, you are going to be conservative the other way around. What does that mean? It means you are going to book the lowest number, the lowest loss. Hold on a second. If I'm conservative, I should book the highest cost, highest loss. Well, no, and you're going to see why in a moment. Therefore, we're going to debit environmental cleanup loss, 1,250,000. We're going to debit lawsuit liability, 1,250,000. This is what we're going to do under those circumstances. Now, why we're going to do so? Let me illustrate why we do so. What happens if the estimate is wrong and the actual loss was 1,750,000? So now what we're saying is, okay, you booked 1,250,000, but the actual loss was 1,750,000. What do we have to do under those circumstances? Not a problem at all. We're going to debit lawsuit liability, 1,250,000 to remove this liability. So this liability is gone. We're going to debit. We're going to credit cash because we are responsible for 1,750,000 and we're going to debit a loss for half a million. So simply put what we did is, look, we did not run away from the loss. We booked the loss, a total loss of 1,750,000. Well, why didn't you went with the higher estimate? Why didn't you go, for example, with 2 million? Well, if you went with 2 million, then you will have to reduce it. You have to reduce your liability and book again of 250. So the idea behind it is if you booked the higher amount and the actual was lower, then you have to book again. And what GAAP don't like is booking those gains that don't make any sense. So you'll show a gain because you made a bad estimate. Well, then you can basically kind of monkey with the numbers, book a high estimate, then when it settles, it settles for less, you book again. So they don't want you to eventually book again. They prefer to book a loss for now and later on add to that loss. It's a little bit against what we know about conservatism, but that's how they want you to do it. So if there is no most likely estimate, go with the lowest amount. It's against, initially you would think it's against conservatism, but the point is to avoid booking again later on. So it's conservative on that end. Now, the best way to learn about this more, you have to go to my website, farhatlectures.com, multiple choice and look at additional resources. At the end of this recording, once again, I'm going to remind you whether you are a student or a CPA candidate, invest in yourself. Don't shortchange yourself. Your accounting career will pay you dividend for years. You just have to focus for the next two to three years, focus on your career, throw everything on this. You will get there. Good luck, study hard, and of course, stay safe. The CPA exam is worth