Many contingent liabilities do not appear in the balance sheet and instead are j

Question

Many contingent liabilities do not appear in the balance sheet and instead are just disclosed in the footnotes to the financial statements. Research one public company’s current financial statement and locate the footnotes on contingent liabilities.

The company analyzed for this purpose is “Pfizer” for the year 2016.In annual report of Pfizer, one of the note to the balance sheet (Note 17 – Commitments and Contingencies), there are various items of contingent nature are disclosed. One item is the legal proceeding against the company. The company expects that the probable loss and it has estimated the loss from the legal proceeding. It has also accrued the liability in the accounts. (Note 17A1. Commitments and Contingencies: Legal Proceedings––Patent Litigation. For information on risks related to patent protection and intellectual property claims by third parties, see "Risks Related to Intellectual Property" in Part I, Item 1A, “Risk Factors” in our 2016 Form 10-K.)

Provide an explanation of the types of contingent liabilities included in the footnotes. What is the GAAP accounting rule in order for a liability to be actually recorded and included in the balance sheet section? Why aren’t the liabilities y from the footnotes included in the liability section of the balance sheet? Why is it important for users of financial statements to read the footnotes and pay attention to the contingent liability section?

Explanation / Answer

Answer

1. Type of contingent Liabilities included in footnotes:-

As per GAAP contingent Liabilities can be broken into three categories based on likelihood of their occurrence. A high probability contingency is a liability that is probable of both occurring and where costs can be reasonably estimated. For high probability contingent Liabilities, the companies must disclose the estimated amount of potential loss and also describe contingency in footnotes of financial statement.

A medium probability contingency is one which falls short of the either parameters as in a high probability contingency. These are disclosed by way of footnotes if either of two criterion are true. First if contingency is probable but loss cannot be estimated or if contingency is reasonable possible although not necessarily probable.

Lastly GAAP qualifies other contingent liability as low probability. The likelihood of these actually occurring is very low, and therefore these are not required to be reported in financial statements.

It is extremely important for a user of financial statements to read the footnotes and pay attention to contingent liability section so as to take an informed view of the pending litigations or other outcomes which can have a significant impact on financial position and cash flows.

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