Contingencies Under ASC 450 vs IAS 37: Probable, Reasonably Possible, Remote, and Why the Same Lawsuit Books Differently

Under US GAAP, "probable" means likely to occur. Under IFRS it means more likely than not. The words look the same in a fact pattern and they are not the same threshold: a lawsuit with a 60% chance of an unfavourable outcome is a provision under IAS 37 and, for most US preparers, only a disclosure under ASC 450. The same claim can sit on the balance sheet of a Saudi company and in the footnotes of its American competitor, and both are right.

Contingencies are a small topic with a large vocabulary, and FAR tests the vocabulary as much as the numbers. Three probability tiers, two conditions for accrual, one rule for a range, and a set of special cases (warranties, guarantees, gain contingencies, unasserted claims) that each carry a trap. This article sets out the US model in full, then the IFRS model beside it, and then the fact patterns the exam uses to tell whether you know which is which.

The US model: ASC 450

A loss contingency is an existing condition involving uncertainty about a possible loss that will be resolved by a future event. ASC 450 sorts the likelihood of that event into three tiers and attaches a treatment to each.

Likelihood	ASC 450 definition	Treatment
Probable	The future event is likely to occur	Accrue, if the amount can be reasonably estimated; disclose
Reasonably possible	More than remote but less than likely	Disclose the nature and an estimate of the loss or range, or state that an estimate cannot be made
Remote	The chance is slight	No accrual, no disclosure, except for certain guarantees

Accrual needs both conditions: probable, and reasonably estimable. A loss that is probable but cannot be estimated is disclosed, not accrued. A loss that can be estimated to the riyal but is only reasonably possible is disclosed, not accrued. Candidates lose marks by treating either condition alone as sufficient.

The range rule. When the loss is probable and the estimate is a range, the amount accrued is the best estimate within the range. When no amount in the range is a better estimate than any other, ASC 450 requires accrual of the minimum, with the additional exposure disclosed. A lawsuit that will probably cost between 1,000,000 and 3,000,000, with nothing to favour one figure, is accrued at 1,000,000 and the possible further 2,000,000 is disclosed. Accruing the midpoint here is the single most common wrong answer on the topic.

Gain contingencies are not recognised until realised. A company that will probably win 5,000,000 in a claim against a supplier records nothing and discloses carefully, avoiding "misleading implications as to the likelihood of realization." The asymmetry is deliberate: losses are anticipated, gains are not.

The IFRS model: IAS 37

IAS 37 uses different words for the same three tiers and a different word for the liability. A provision is recognised when there is a present obligation from a past event, an outflow is probable, and a reliable estimate can be made. A contingent liability is a possible obligation, or a present one that fails the probability or estimate test, and it is disclosed. A remote outflow is neither recognised nor disclosed.

Question	ASC 450	IAS 37
"Probable" means	Likely; in practice a high threshold	More likely than not; above 50%
Amount in a range, no best estimate	The minimum	The midpoint, as the best estimate
Large population of similar items (warranties)	Expected cost, accrued	Expected value, weighting each outcome by its probability
Discounting	Generally not, unless timing and amount are fixed or reliably determinable	Required when the time value of money is material
Word for the accrued amount	Accrued liability or loss contingency	Provision
Word for the disclosed-only item	Loss contingency, disclosed	Contingent liability
Gain contingencies	Not recognised until realised	Contingent asset: disclosed when probable, recognised when virtually certain
Onerous contracts	No general provision	Provision for the unavoidable cost
Restructuring	Liability when the cost is incurred, under ASC 420	Provision when a detailed formal plan exists and has been announced (a constructive obligation)

Three of those rows produce different numbers from the same facts. The 1,000,000 to 3,000,000 lawsuit is accrued at 1,000,000 under ASC 450 and provided at 2,000,000 under IAS 37. A 60% likely loss is disclosed under US GAAP by most preparers and provided under IFRS. A five-year environmental obligation is carried undiscounted under US GAAP and discounted under IFRS, with the unwinding of the discount charged as a finance cost each year. A candidate who has prepared IFRS statements will find the IAS 37 answers natural and the ASC 450 answers arbitrary; the exam wants the arbitrary ones.

The special cases

Warranties

A product warranty is a loss contingency that is always probable in aggregate, so the expected cost is accrued in the period of sale, matched against the revenue, and the accrual is reduced as claims are paid. If the company sells an extended warranty separately, that is a revenue item under ASC 606, deferred and recognised over the coverage period, not a contingency; the five-step model handles it. A question that gives sales, a warranty percentage and actual claims is asking for the year-end liability: opening balance plus the accrual less the claims paid.

Guarantees

A guarantee of another party's debt is the exception to the remote tier. The nature and amount of a guarantee are disclosed even when the chance of paying is remote, and under ASC 460 the guarantor records a liability at fair value for the obligation to stand ready, separate from any contingent loss.

Unasserted claims

A claim nobody has yet made is a contingency only if it is probable that it will be asserted. If assertion is probable, the claim is then run through the ordinary tiers: probable and estimable, accrue; reasonably possible, disclose. If assertion is not probable, nothing is recorded or disclosed. Two probability judgements stacked on each other, and the exam asks about the first one.

Subsequent events

A lawsuit pending at year end and settled before the statements are issued is a recognised subsequent event: the settlement provides evidence about a condition that existed at the balance sheet date, and the accrual is adjusted to the settled amount. A lawsuit arising from an event after year end is a nonrecognised subsequent event: disclosed if material, not accrued. The date of the underlying event, not the date of the claim, decides which.

The lawyer's letter

The probability judgement on litigation is management's, and the evidence for it comes from the entity's legal counsel. Under AU-C 501 the auditor asks management to send a letter of inquiry to the lawyers handling the matters, and the lawyers respond with their assessment of the likelihood of an unfavourable outcome and, where they can, an estimate of the loss. A lawyer who declines to estimate is not being unhelpful; "cannot be estimated" is a permitted answer, and the accounting follows it. A lawyer who refuses to respond at all is a scope limitation for the auditor, which is the point at which this topic crosses into AUD.

What the disclosure says

For an accrued loss, the nature of the contingency and, where necessary to keep the statements from being misleading, the amount accrued. For a reasonably possible loss, or a probable one that could not be estimated, the nature, and an estimate of the possible loss or range, or a statement that an estimate cannot be made. The exam tests the third alternative more than candidates expect: "an estimate cannot be made" is a permitted disclosure, and a question that says the amount is not estimable is not asking you to invent one.

How FAR asks

Fact pattern	Answer
Probable loss, range 400,000 to 900,000, no best estimate, US GAAP	Accrue 400,000; disclose exposure up to 900,000
Same, IFRS	Provide 650,000
Probable loss, counsel cannot estimate	Disclose; do not accrue
Reasonably possible loss of exactly 250,000	Disclose; do not accrue
Probable recovery of 5,000,000 from insurer	Do not recognise; disclose without implying realisation
Guarantee of affiliate's loan, default remote	Disclose the guarantee; record the stand-ready obligation at fair value
Claim settled after year end for a pre-year-end event	Adjust the accrual to the settlement
Warranty: 2% of 10,000,000 sales, 120,000 claims paid, opening balance 50,000	Year-end liability 130,000

Where to practise this

Contingencies are examined as short items with one decision each, which makes them ideal for volume practice. Prepito's FAR course covers ASC 450 and the related subsequent events guidance with practice questions that name the tier, the condition and the amount in every explanation. The SOCPA Financial Accounting course covers IAS 37 provisions, contingent liabilities and contingent assets. The FAR study guide places the topic in the blueprint, and deferred taxes is the neighbouring topic where "more likely than not" reappears with a different meaning.

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Sources: FASB Accounting Standards Codification, Topic 450, Contingencies, and Topic 460, Guarantees, IFRS Foundation, IAS 37 Provisions, Contingent Liabilities and Contingent Assets, AICPA CPA Exam Blueprints. Worked amounts are illustrative; the standards are amended periodically, so confirm the current text for a specific case.