You cannot always take a balance sheet at face value because it may omit certain valuable assets and costly future obligations. Here are examples of items that may not be reported on a company’s balance sheet and a closer look at the rules for recording contingent losses under U.S. Generally Accepted Accounting Principles (GAAP).
What GAAP requires
Patents, brands, goodwill, and other intangible assets provide significant value for many companies. Acquired intangibles may be reported at their fair value and either amortized over time or tested at least annually for impairment. But, the values of internally generated intangible assets are generally not included on a GAAP-basis balance sheet.
On the other hand, pending litigation, governmental investigations and other contingent losses may be reported on the balance sheet as an accrued liability, disclosed in the footnotes or omitted from the financial statements, depending on how they are classified under GAAP. Accounting Standards Codification (ASC) Topic 450, Contingencies, requires companies to classify contingent losses as ‘probable’ (that is, likely to occur), ‘remote’ (meaning the chances that a loss will occur are slight), or ‘reasonably possible’ (falling somewhere between remote and probable).
When to report or disclose
Under GAAP, a company must record an accrued liability only if a contingent loss is probable and the amount (or a range of amounts) can be reasonably estimated. If it cannot be reasonably estimated, companies must disclose the nature of a probable contingency and explain why the amount cannot be quantified.
If a contingent loss is reasonably possible, the company must disclose it but does not need to record an accrual. The disclosure should include an estimate of the amount (or range of amounts) of the contingent loss or an explanation of why it can’t be estimated. If a contingent loss is remote, no disclosure or accrual is required.
Reporting contingencies requires professional judgment. We can help you classify and estimate losses to help give investors a clearer picture of your company’s financial position and protect against shareholder claims in the event a loss occurs.