 Hello, and welcome to the session in which we will discuss what is a contingent liability? Contingent liability is a good illustration of why you will need to take far or why you should take financial accounting and Reporting before you take the auditing section of the CPA exam Because on the auditing exam you will face topics from far that you need to know how to deal with it when it comes to Auditing so if you know it from a financial accounting perspective It will be easy to audit those items or to learn how to audit these items So we're gonna start by reviewing real quick. What is a contingent liability a contingent liability is a potential liability? It's under gap that may arise from a past event and is dependent on the future event future outcome That may or may not occur. So what does that mean something happened in the past and Because of the result of that event We might have an obligation or a liability into the future and that liability may or may not happen Depend on depending on certain event now certain liabilities. They are clear cut. You cannot argue with them I'll give you an example other contingent liabilities. We may not be so sure we have to wait for the outcome So it's an uns it's an uncertainty about the company's liability that would only become real When that future event occurs So what are some typical examples of contingent liabilities? The most typical one is a lawsuit a legal claim someone sues you and you're waiting You're waiting to see whether you're gonna win or lose this lawsuit a product warranty and environmental remedies costs such as the British petroleum spill in the Gulf of Mexico that cost British petroleum 40 billion now, they know they know they know for sure they're gonna have a liability But did they know the amount that's important and we'll talk about that soon also guaranteeing the debt of others could be a potential liability Let's assume you guarantee the debt of another company. What happened if that other company cannot pay? What's your what is your obligation here? Do you have a contingent liability as well as other examples? But those are usually the main ones before we proceed any further I have a public announcement about my company farhat lectures comm Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker Roger Wiley Gleam miles my accounting courses are aligned with your accounting courses broken down by chapter and topics My resources consist of Lectures multiple choice questions true false questions as well as exercises go ahead start your free trial today No obligation no credit card required The question is when to record so when to book when to Report a contingent liability. Well under gap a contingent liability should be reported should be recorded in The financial statement the technical word is recognized when two conditions are met. The first condition is it is probable Probable means what probable means more likely than not under gap. They assume three problems three conditions We have what we call the remote Remote possibility means no chance you are going to lose there is possible Possible and the highest one is Probable so we're talking about probable the event that's occurring that's gonna be occurring is probable There's a good chance. You are going to lose now. What is that percentage? I don't know It's a high percentage that the future event will occur and it will result in a financial obligation again Think of a lawsuit Companies get sued all the time if there is no chance you are going to lose there is a remote chance Just it's a water under the bridge. You don't mention it. What if the what if the What if the probability is possible? Well under those circumstances you disclose What if the possibility is probable? Well, we have to find out if it's probable we need to meet one more condition if it's probable plus You know the amount in other words you need to know the amount and it's probable when those two conditions exist so the two conditions is the Probable plus the amount amount means the dollar amount Plus the dollar amount. This is gonna give you a liability What if it's only probable if it's only probable you will disclose just FYI So two conditions have to exist and I know for a fact not I know for a fact I heard from many CPA candidate that this topic is testable when do you record the potential liability when two conditions exist? The probability is high, which is probable more likely than not and plus remember the plus plus the amount You can estimate the amount with certain certainty when those two conditions exist You have a contingent liability that you have to record if the amount cannot be reasonably estimated as I told you the liability should be Disclosed not recorded disclosed in the financial statement But the specific amount should not be recorded disclose means disclosed in the note In addition to recording the liability the company must also provide adequate disclosure So if you do record a liability because of those those two conditions exist You would still do a disclosure of course because you want for example if you're being sued in which jurisdiction Who's the plaintiff? Why are they suing you? What is the potential outcome? How long it's going to take those are all estimates nevertheless you have to discuss them You just you don't tell someone I just have a lawsuit. Tell me where Who's suing you for what purpose in which jurisdiction? When do you expect to have a? Response from the jury or the judge and the potential financial impact on On on the financial statements and what is your plan as a company to mitigate the risk of that contingency occurring? now from an auditor's perspective Because everything that I talked about you would learn and a financial accounting course now from an auditor's perspective We need how do auditors identify contingent liabilities? And this is what we're concerned about the first thing is you ask management inquiry of management The auditor will ask questions of the company's management to gain to gain an understanding of the company's operation and any potential Contingent liabilities, what do we mean by management? Well, you talk to the purchasing manager about any long-term purchase contract or commitments Do we have any of those they could arise they could give us a potential liability Ask about various contracts review them loan agreement loan guarantees leases Bank confirmation that could show that we have we are guaranteeing the debt of others Review the minutes for the board of directors people on the top executive committee top management because if there's any lawsuit anything important They may talk about that they may talk about it in those meetings And you will catch it in the minutes because they would record those minutes Review any communication between the company and the lawyer and lawyer or lawyers? It doesn't matter review communication between the company and any regulatory agency Now obviously if you're auditing a company and the company could be subject to regulatory agencies like Environmental agencies or any sort of regulatory agencies. You need to be familiar with the framework of that of the operation of the company So if they possibly could have a lawsuit you should have your Radars up and running to kind of try to catch any lawsuit Talk to the lawyers inquiry with client attorneys. You would send them a letter and there is a one-hole recording about this, you know, how to What how to ask the lawyers and what's the lawyers responsibility? But simply put you have to ask the lawyers about any potential litigation read interim financial statements and notes now if you're reporting the end year look at the Quarters you might find something that we mentioned like hold on a second What happened to this case, right? And the most important one last but not least is a Representation letter or a rep letter and you'll hear this rep letter again and again in an audit course or the CPA exam And what is that? Basically the rep letter It's the company the management telling you about Anything that they wanted to tell you you asked them about but you want it in writing So if the manage management says we have the following lawsuit ABC and they did not tell you about D and E Well, what did it not tell me? I mean I did my job I did what I'm supposed to do But you're also supposed to tell me if there's anything else tell me in that rep letter or representation letter And that's why I have it in caps because rep letter appears again and again in various assurance services Basically what you want to do what the what the auditor trying to do is in a sense push the responsibility to management You told me this put it in writing that that's the only thing that you know You are aware about in terms of how many lawsuits or any contingent liability because it's your responsibility at the end of the day I mean, I'm gonna look for things But I may not be able to catch everything But at least you told me that you told me everything that you know that's gonna give me some assurance from an auditor's perspective That legally I may be able to protect myself down the road What should you do now go to far hat lectures and do what work MCQs? Preve previously released a ICPA questions Multiple choice questions. That's gonna help you understand this topic invest in yourself invest in your career This topic is easy and this topic is testable testable means you can get few points to get the 75 to pass your exam and Move on with your career and have a better life. Good luck everyone study hard and of course stay safe