Accounting for Contingencies & Environmental Liabilities

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  • 0:01 Contingencies
  • 0:52 Gains
  • 2:26 Liabilities
  • 4:22 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

Sometimes in business, things happen that can impact the bottom line of the company. But how do you plan for the financial aspect of these possible events? In this lesson, we'll look at how to account for contingencies and environmental liabilities.

Contingencies

Kelly is an accountant at a big company. She takes care of all their bookkeeping and makes sure that they pay their taxes. But she has a question. Her company used to produce a lot of hazardous waste, which they cleaned up. But there is some cleanup that they still have to do. How does Kelly account for the cost of the cleanup that hasn't been done yet?

A contingency in accounting is something that is likely to happen in the future that could affect a company's profits. For example, the cost of cleaning up the hazardous waste is likely to happen in the future, and because it will cost money, it will hurt the bottom line of Kelly's company.

To help Kelly figure out how to account for the hazardous waste cleanup, let's look at the two main types of contingencies: gain contingencies and liability contingencies.

Gains

Kelly understands that contingencies are the things that might happen in the future that could affect her company's bottom line. But she's heard that there are two types of contingencies, and she isn't sure what they are.

The first major type of contingency is gain contingencies, or things likely to happen in the future that will affect the bottom line of the business in a positive way. That is, gain contingencies have the ability to make the company more profitable and/or worth more money in the future. The company stands to gain from them, so they are called gain contingencies.

For example, when going through the books for her company, Kelly noticed that there's a deduction that she hasn't planned for. This could lead to the company receiving a tax refund. The tax refund is a gain contingency.

Other examples of gain contingencies include litigation that could lead the company to being paid a sum of money for damages, possible government contracts or regulations that would be favorable to the company if passed, and certain types of assets that could bring in money if sold. All of these could help the company out, so they are gain contingencies.

Kelly should be conservative in her accounting for gain contingencies. In other words, she should only include them in statements if they are pretty much guaranteed to happen and she knows how much the company will gain. For example, once she knows for sure that the company is going to receive a tax refund and she knows how much that refund will be, she can enter it into the books even if the refund check hasn't arrived yet.

Liabilities

A tax refund sounds great, but Kelly realizes that the cleanup from the hazardous waste is not a gain contingency. It will cost her company money, so it can't be classified as a gain.

The second type of contingency is liability contingencies, or things likely to happen in the future that will affect the company's bottom line in a negative way. That is, these things will cost the company money or will potentially lower the profit or value of the company. They are a liability, in other words, which is where the name comes from.

Kelly's company cleanup is an example of a liability contingency. It will cost the company money, reducing profits, so it is a liability. Other examples of liability contingencies include litigation against the company and product warranties, among others.

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