Sales and use taxes: Loss contingencies.

• Author: McCrillis, Scott

FASB Accounting Standards Codification (ASC) Topic 450, Contingencies, requires companies to assess the degree of probability of an unfavorable outcome before reporting a loss contingency. According to Topic 450, when a loss contingency exists, the likelihood that future events will confirm the loss or impairment of an asset or the incurrence of a liability can range from "probable" to "reasonably possible" to "remote." This item discusses these standards in the context of potential loss contingencies related to sales and use taxes.

Rule

ASC Subtopic 450-20 defines a loss contingency as "[a]n existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur."

Accrual of a loss contingency is required when (1) it is probable that a loss has been incurred and (2) the amount can be reasonably estimated. As such, a company must determine the probability of the uncertain event and demonstrate the ability to reasonably estimate the loss from the uncertain event in order to accrue a loss contingency. However, loss contingencies that do not meet both of these criteria for recognition may still need to be disclosed in the financial statements.

Analysis

The analysis in determining whether a company is required to make an accrual or disclosure begins with determining the likelihood of the future event. In this context, there are three potential options as defined by Subtopic 450-20: "probable," "reasonably possible," and "remote."

Probable: The ASC master glossary's definition of "probable" provides no quantitative thresholds, so the company should exercise judgment when applying the term. According to the glossary, "probable" is defined as "the future event or events are likely to occur." If the likelihood of a material loss is probable, then the company must move to the second piece of the standard, which is to determine whether the amount of the loss is reasonably estimable.

If the amount of the loss is reasonably estimable, then the company is required to make an accrual for the loss contingency. The company is required to accrue either (1) the company's estimate of the loss, or (2) if the reasonably estimable loss is a range, then it must accrue either the amount within the range that appears to be the better estimate or the minimum amount in the range.

If the amount of the loss is not reasonably estimable, then the...