Contingencies, Loss Recoveries, and Guarantees

If the recognition criteria for a contingent liability are met, entities should accrue an estimated loss with a charge to income. If the amount of the loss is a range, the amount that appears to be a better estimate within that range should be accrued. If no amount within the range is a better estimate, the minimum amount within the range should be accrued, even though the minimum amount may not represent the ultimate settlement amount. Discounting contingent liabilities is generally prohibited.

Recoveries of recognized losses (e.g., insurance recoveries) may be recognized when it is probable that they will be received and the amount is reasonably estimable. However, such recoveries cannot be recognized in amounts that exceed the recognized losses because such an excess represents a gain contingency. It is often difficult to determine whether an amount to be received represents a loss recovery, a gain contingency, or a combination of both.

The determination of whether an arrangement qualifies as one of these types of contracts is often difficult because there is limited interpretive guidance on each type; an entity will therefore need to use judgment in making this determination. Further, because ASC 460 only discusses the characteristics of each type of guarantee contract, entities often focus on ASC 460’s examples of the types of contracts that meet the definition of a guarantee in determining whether a contract is subject to ASC 460. To make matters even more complex, there are a number of scope exceptions related to applying the recognition guidance, disclosure guidance, or both.

Guarantee liabilities must be initially recognized at fair value. A fair value estimate for such liabilities will include an amount for an entity’s stand-ready (noncontingent) obligation that it assumes when the contract is issued. However, ASC 460 does not address the subsequent measurement of such liabilities other than to require that an entity apply the guidance on contingent liabilities to any contingent loss arising from the contract. As a result, an entity needs to adopt accounting policies that address both (1) the release of the liability recognized at the inception of the contract and (2) the accounting for contingent losses that arise, including how the recognition of those losses intersects with the previous recognition of the amounts for the noncontingent component. Because of the lack of specific guidance on this topic, diversity in practice exists.

In addition to the disclosure requirements for contingent liabilities in ASC 450-20, entities must comply with ASC 460’s disclosure requirements that specifically apply to guarantees.