ASC 450-20: Explanation of Legal Claim Contingent Liability & Journal Entries

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Contingencies are uncertain events or conditions that may occur in the future, with outcomes dependent on one or more factors. In accounting, the term "contingencies" refers to potential liabilities and losses that may arise from such events or conditions. The Accounting Standards Codification (ASC) Topic 450-20, also known as "Loss Contingencies," provides guidance for reporting contingent liabilities and losses in financial statements. This article will explain the concept of legal claim contingent liability transactions under ASC 450-20 and provide examples of journal entries that illustrate the proper accounting treatment for these transactions.

 

Legal Claim Contingent Liability Transaction

A legal claim contingent liability transaction occurs when an enterprise is involved in a lawsuit, claim, or assessment, and the outcome is uncertain. Under ASC 450-20, an enterprise is required to recognize a loss contingency if it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. If both conditions are met, a company must accrue the estimated loss and disclose the relevant information in the financial statements.

 

Journal Entries for Legal Claim Contingent Liability Transaction

To better understand the accounting treatment for legal claim contingent liability transactions, let's look at a hypothetical example.
 

Example:

Company A is involved in a lawsuit, and after consulting with legal counsel, they determine that it is probable they will lose the case. The legal counsel estimates a potential loss of $500,000.

 

Journal Entry 1: Accrue the estimated loss
 

Company A would record the following journal entry:

Debit: Legal Expense $500,000

Credit: Legal Claims Payable $500,000
 

The debit to the legal expense represents the estimated loss due to the legal claim, while the credit to the legal claims payable represents the liability for the claim.

 

Journal Entry 2: Adjust the accrual (if necessary)

If the estimated loss amount changes before the resolution of the lawsuit, Company A would need to adjust the accrual accordingly. For example, if the estimated loss increases to $600,000, the company would record the following journal entry:
 

Debit: Legal Expense $100,000

Credit: Legal Claims Payable $100,000
 

This entry adjusts the accrued liability to reflect the updated estimate of the loss.

 

Journal Entry 3: Record the settlement of the legal claim

When the lawsuit is finally settled, Company A would need to record the actual settlement amount. For example, if the settlement amount is $550,000, the company would record the following journal entry:
 

Debit: Legal Claims Payable $500,000

Debit: Legal Expense $50,000

Credit: Cash $550,000
 

This entry removes the liability recorded for the legal claim, adjusts the legal expense to reflect the actual loss incurred, and records the cash outflow for the settlement.

 

ASC 450-20 establishes guidelines for recognizing and reporting loss contingencies in financial statements. By following these guidelines, companies can provide a clearer and more accurate picture of their financial position to investors, creditors, and other stakeholders. It is crucial for accountants and financial professionals to understand the proper accounting treatment for legal claim contingent liability transactions to ensure compliance with the ASC 450-20 standard.