Loss Contingencies

General rules for loss contingencies. An estimated loss from a contingency is accrued by recording a decrease in net assets and the recording of a liability if both of the following conditions are met:

1. Information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements.
2. The amount of loss can be reasonably estimated.

If the loss contingency is probable but only a range of estimated values can be made, the minimum point of the range should be accrued and the maximum point should be disclosed.

If the loss contingency is at least reasonably possible, a liability should not be recorded but disclosure is required. If feasible, that disclosure should include an estimate of the loss or range of loss. If a reasonable estimate of the loss cannot be made, that fact should be disclosed. (FASB ASC 450-20-50-3)

Certain contingencies are remote, in which case disclosure in financial statements is not required unless a guarantee has been given (see discussion below). No disclosure is required for unasserted claims or assessments when no act by the potential claimant has transpired. In addition, general or unspecified business risks are neither accrued nor disclosed.

In addition, a loss contingency should be disclosed if it involves a guarantee, even if the likelihood of loss is remote.

In summary, the accounting requirements are as follows for loss contingencies:

1. If the likelihood of the loss is probable, and the loss can be reasonably estimated, then
   • Accrue the loss and disclose the contingency.
2. If the likelihood of the loss is probable, and the loss cannot be reasonably estimated, then
   • Do not accrue the loss but disclose the contingency in the financial statements.
3. If the likelihood of the loss is reasonably possible, and the loss can be reasonably estimated, then
   • Do not accrue the loss but disclose the contingency.
4. If the likelihood of the loss is reasonably possible, and the loss cannot be reasonably estimated, then
   • Do not accrue the loss but disclose the contingency.
5. If the likelihood of the loss is remote, then
   • Do not accrue the loss; disclosing the contingency is only required if it involves the guarantee of indebtedness. A not-for-profit organization, of course, can always decide to include a disclosure of a remotely possible contingency, even if GAAP would not require the disclosure.

In cases where loss contingencies may arise after the financial statement date but before the financial statements are issued, FASB ASC 450-20-50 states that disclosure may be needed to prevent the financial statements from being misleading.

Some not-for-profit organizations may employ the practice of classifying a portion of net assets as appropriated for loss contingencies. This practice is acceptable when the following criteria are met:

1. Appropriate net assets must be clearly identified and shown within the appropriate net asset classification on the statement of financial position.
2. Losses should not be charged to appropriated net assets. Furthermore, no part of appropriated net assets may be transferred to revenue or used in any way to affect the determination of the change in net assets.

Specific Loss Contingencies

The following is a discussion for applying the accrual requirements to specific contingencies that are common to not-for-profit organizations.

Noncompliance with donor or grantor restrictions. This is one of the more common loss contingency areas that is somewhat unique to not-for-profit organizations. Donors occasionally impose restrictions on not-for-profit organizations. Noncompliance may cause the organization to lose future revenues or support from the donor, or require the not-for-profit organization to reimburse the donor for previous donations.

In addition, not-for-profit organizations frequently receive financial assistance from governmental entities. By accepting the assistance, the not-for-profit organization is generally subject to laws and regulations, noncompliance with which may have a direct and material effect on the determination of amounts in their financial statements. For example, such laws may direct the types of goods or services that the organization may provide; the eligibility of those to whom the organization can provide benefits; the amounts organizations must contribute from their own resources toward projects; and principles and standards for determining the direct and indirect costs that are allowable as charges to government financial assistance programs.

If it is probable that a restricted donation or financial assistance will have to be reimbursed to the donor or grantor, and the amount of the reimbursement can be reasonably estimated, a contingent liability should be accrued.

In addition, audits in progress or completed by grantors of these specific grants or contracts, as well as the results of Single Audits performed in accordance with Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (commonly referred to as the Uniform Guidance) relating to expenditures under federal awards programs, should also be considered.

Noncompliance with restrictions imposed on an organization by a donor should be disclosed if there is a reasonable possibility that a material contingent liability has been incurred at the date of the financial statements or there is at least a reasonable possibility that the noncompliance could lead to a material loss of revenue or could cause an entity to continue as a going concern. For example, if the noncompliance resulted in the termination of an organization's most important contract with the grantor, the organization may have lost its largest source of revenue. This impact needs to be assessed.

Allowance for uncollectible receivables. An allowance for uncollectible receivables, including pledges and contributions receivable, should be recorded if both of the following conditions are met:

1. It is probable that these receivables recorded at the financial statement date will not be collected.
2. The uncollectible amount can be reasonably estimated. While the estimated amount of pledges that are uncollectible may be difficult to estimate, consideration should be given to the historical experience of fundraising appeals performed in the past.

The purpose of the allowance is to properly measure the value of receivables as a whole. Accordingly, an allowance should be recorded even if specific uncollectible receivables cannot be identified.

An organization may be unable to reasonably estimate uncollectible receivables. This inability might preclude it from recording an allowance and may indicate that it should use the installment method, cost recovery method, or other method to recognize revenues.

Expropriation of assets. The threat that a government will expropriate an organization's assets is a contingency. A loss should be accrued if:

1. Expropriation is imminent and a loss is expected.
2. The amount of the loss can be reasonably estimated.

An expropriation's imminence may be indicated by a government's public or private declarations of intent or its actual expropriation of another organization's assets. (FASB ASC 450-20-55-9) Many not-for-profit organizations with worldwide missions often have operations and assets in countries outside of the United States. This contingency is often overlooked by not-for-profit organizations' financial statement preparers. This contingency could very conceivably result in a required (and useful) financial statement disclosure if the appropriate conditions are met. Obviously, a loss should be accrued if the two conditions above are present.

Claims-made insurance policies. The claims-made coverage insures only those claims that are reported to the insurance company during the policy period. Therefore, the organization has a liability for any losses incurred during the policy period that have not been reported to the insurance company.

An organization should record a liability for probable losses from claims incurred but not reported during the policy period if the losses are both probable and reasonably estimable. Losses that are reasonably possible or probable but cannot be reasonably estimated should be disclosed.

Litigation and claims. A loss due to pending or threatened litigation, or actual or possible claims and assessments, should be accrued if all of the following conditions are met: (FASB ASC 450-20-55)

1. The underlying cause of the litigation, claim, or assessment occurred on or before the financial statement date.
2. The likelihood of an unfavorable outcome is probable.
3. The amount of the loss can be reasonably estimated. It should be noted that if the estimate is provided in a range, the lowest amount in the range should be accrued unless another amount in the range is more appropriate. If it is reasonably possible that the actual loss will exceed the amount accrued, the additional exposure to loss should be disclosed.

The criteria for disclosing or accruing the contingency when a claim or assessment is unasserted are somewhat different. The organization must first determine whether it is probable that a suit will be filed or a claim or assessment asserted. Based on the assessment, the following is applicable:

1. No disclosure or accrual is required unless it is probable that a claim will be asserted.
2. Accrual and disclosure are required if:
   1. It is probable that a claim will be asserted.
   2. It is probable that the outcome will be unfavorable.
   3. The amount of loss can be reasonably estimated.
3. Disclosure is required if:
   1. It is probable that a claim will be asserted and its outcome will be unfavorable, but the amount of loss cannot be reasonably estimated, or
   2. It is probable that a claim will be asserted and reasonably possible, but not probable, that the outcome will be unfavorable.

Joint and several liability. The FASB issued ASU 2013-04 Liabilities (Topic 405) Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (ASU 2013-04) to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting deadline, except for obligations addressed in existing GAAP guidance. Examples of obligations within its scope provided by ASU 2013-04 include debt arrangements, other contractual obligations, and settled litigation and judicial rulings. Obligations accounted for under other GAAP are specified in ASU 2013-04 as follows:

1. Asset Retirement and Environmental Obligations, Topic 410;
2. Contingencies, Topic 450;
3. Guarantees, Topic 460;
4. Compensation—Retirement Benefits, Topic 715;
5. Income Taxes, Topic 740.

ASU 2013-04 points out that there is a diversity in current practice as to how these obligations are recorded. Some entities record the entire amount under joint and several liability arrangements, while other entities record less than the total amount of the obligation, using allocations or the portion of the amount the entity agrees to pay its co-obligors.

ASU 2013-04 provides that an entity should measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is within its scope and is fixed at the reporting date as the sum of:

1. The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors.
2. Any additional amount the reporting entity expects to pay on behalf of its co-obligors. If some amount within a range of the additional amount the reporting entity expects to pay is a better estimate than any other amount within the range, that amount shall be the additional amount included in the measurement of the obligation. If no amount within the range is a better estimate than any other amount, the minimum amount in the range shall be the additional amount included in the measurement of the obligation.

In addition, the entity is required to disclose the following information about each obligation, or each group of obligations, resulting from joint and several liability arrangements within the scope of ASU 2013-04:

1. The nature of the arrangement, including:
   1. How the liability arose;
   2. The relationship with other co-obligors;
   3. The terms and conditions of the arrangement.
2. The total outstanding amount under the arrangement, which shall not be reduced by the effect of any amounts that may be recoverable from other entities.
3. The carrying amount, if any, of an entity's liability and the carrying amount of a receivable recognized, if any.
4. The nature of any recourse provisions that would enable recovery from other entities of the amounts paid, including any limitations on the amounts that might be recovered.
5. In the period the liability is initially recognized and measured or in a period the measurement changes significantly:
   1. The corresponding entry;
   2. Where the entry was recorded in the financial statements.

ASU 2013-04 is effective for fiscal years and interim periods within those years, beginning after December 15, 2013. For nonpublic entities, ASU 2013-04 is effective for fiscal years ending after December 15, 2014, and interim periods and annual periods thereafter.

Uninsured risks. Losses from uninsured risks that relate to future periods should not be accrued in the current period because they should be recognized in the period that a loss occurs. In addition, they generally do not need to be disclosed unless: (FASB ASC 450-20-55-7)

1. An event that would make the likelihood of loss probable occurs subsequent to the financial statement date but before the financial statements are issued.
2. Disclosure is necessary to prevent the financial statements from being misleading.

Guarantees. FASB ASC 460-10 clarifies the disclosure requirements to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing a guarantee. This recognition is an “interpretation” of GAAP contingency requirements as to the initial recording of a liability for the fair value of an obligation resulting from a guarantee. However, GAAP does not provide an approach for the subsequent measuring of the recognized liability over the term of the related guarantee.

The following are the types of guarantee contracts to which the provisions of FIN 45 (FASB ASC 460-10) apply:

• Contracts that contingently require the guarantor to make payments (either in cash, financial instruments, other assets, shares of stock, or provision of services) to the guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party. These types of contracts would include:
  • A financial standby letter of credit, which is an irrevocable undertaking to guarantee payment of specified financial obligation;
  • A market value guarantee on either a financial asset or a nonfinancial asset owned by the guaranteed party;
  • A guarantee of the market price of the common stock of the guaranteed party;
  • A guarantee of the collection of the schedule's contractual cash flows from individual financial assets held by a special-purpose entity.
• Contracts that contingently make payments, as described above, to the guaranteed party based on another entity's failure to perform under an obligating agreement.
• Indemnification agreements that contingently require the indemnifying party to make payments to the indemnified party based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party, such as an adverse judgment in a lawsuit.
• Indirect guarantees of the indebtedness of others.

FASB ASC 460-10 does not apply to every type of guarantee. For example, it lists the following as outside of its scope:

• Guarantees issued by insurance and reinsurance companies and accounted for under the accounting principles for those companies;
• Residual value guarantees provided by lessees in capital leases;
• Contingent rents;
• Vendor rebates;
• Guarantees that prevent the guarantor from recognizing a sale or the earnings from a sale.

In addition, the following types of guarantees are not subject to the initial liability recognition requirements of GAAP, but are subject to its disclosure requirements:

• Product warranties;
• Guarantees that are accounted for as derivatives;
• Guarantees that represent contingent consideration in business combination;
• Guarantees for which the guarantor's obligations would be reported as an equity item, rather than a liability;
• An original lessee's guarantee of lease payments when that lessee remains secondarily liable in conjunction with being relieved from being the primary obligor under a lease restructuring;
• Guarantees issued between either parents and their subsidiaries or corporations under common control;
• A parent's guarantee of a subsidiary's debt to a third party, and a subsidiary's guarantee of the debt owed to a third party by either its parent or another subsidiary of the parent.

There are generally two obligations of a guarantor:

• An obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. This is considered the noncontingent aspect of the obligation that enables a liability for this obligation to be recognized in accordance with SFAS 5 (FASB ASC 450), even if it is not probable that payments will be required under the guarantee.
• A contingent obligation to make future payments if those triggering events or conditions occur.

GAAP requires that the noncontingent liability (first bullet) above be recognized at fair value in the statement of financial position. If a liability for the contingent obligation (second bullet) above is required to be recognized under FASB ASC 450 because it meets the probable and estimable criteria, the liability for the guarantee as a whole should be the greater of the liability for the noncontingent liability and the contingent liability components of the guarantee.

In terms of measuring the initial liability for a guarantee, GAAP provides the following guidance:

• When the guarantee is issued in a stand-alone, arm's-length transaction with an unrelated party, the liability recognized at the inception of the guarantee should be the premium received or receivable by the guarantor.
• When the guarantee is issued as part of a transaction with multiple elements with an unrelated party, the liability should be an estimate of fair value, considering factors such as premiums paid to other guarantors for the same guarantee in similar transactions. If this information is not available, expected present value measurement techniques, such as discounted cash flow, may provide an estimate of fair value.

GAAP also addresses the situation where a guarantee is issued as a contribution to an unrelated party. The liability should be recognized at the inception of the guarantee and be measured at its fair value as contributions are measured at fair value. It also provides an example of a community foundation providing a loan guarantee program to assist a not-for-profit in obtaining bank financing at a reasonable cost. Under this type of program, the community foundation may issue a guarantee of a not-for-profit organization's bank debt. Upon the issuance of the guarantee, the community foundation would recognize a liability for the fair value of the guarantee. The issuance of the guarantee would not be considered merely a conditional promise to give because upon issuance of the guarantee, the not-for-profit organization will have received the gift of the community foundation's credit support, which enables the not-for-profit organization to obtain a lower interest rate for its financing.

While this example is directed to the guarantor, it can be interpreted from the example that the not-for-profit organizations benefiting from the loan guarantee would also record a contribution for the fair value of the guarantee. GAAP does not provide specific guidance as to how to value the guarantee, but without any evidence of premiums paid to the guarantor, the difference in the interest rate obtained with the guarantee compared with the interest rate that would have been obtained without the guarantee and discounted the cash flow differences between the two interest rates seems like a fairly logical and objective method of estimation.

Gain Contingencies

Gain contingencies should be disclosed in the notes to the financial statements; however, the disclosure should indicate that this gain is not certain to be obtained. Contingencies that result in gains should not be accrued because future events still need to occur before this revenue is “earned.”

Loss Contingencies

When disclosures about loss contingencies are required, the following information should be presented:

1. The nature of the contingency;
2. An estimate of the possible loss or range of loss;
3. The amount and nature of adjustments resulting from preacquisition contingencies.

In certain cases where a contingency would be very significant to the financial statements, contingencies arising after the financial statement date may be best disclosed by supplementing the financial statements with pro forma information that reports the loss as if it occurred at the financial statement date.

An audit of the organization's expenditures under a grant received from the Benevolent Foundation has reported questioned costs of $100,000 relating to costs that were charged to this grant. The organization is currently disputing this finding. At this time, the outcome is uncertain and the amount the organization may have to reimburse the Benevolent Foundation cannot be reasonably estimated.

Certain significant risks and uncertainties. FASB ASC 275-10 requires an organization to disclose risk and uncertainties that may significantly affect items reported in the financial statements in the near term. Disclosures required relate to the nature of the organization's operations, use of significant estimates, and the current vulnerability caused by certain categories of concentrations. While designed primarily for commercial enterprises, the disclosure requirements are applicable to not-for-profit organizations.

The above disclosures are specifically not applicable to the following:

1. Change in management or key personnel;
2. Proposed changes in government regulations;
3. Proposed changes in accounting principles;
4. Deficiencies in internal controls;
5. Possible effects of acts of God, war, or sudden catastrophes.

Description/Examples of Required Disclosures

Nature of operations. The disclosure should include a description of the organization's principal or major services or programs, as well as where these services are performed, and the major classes of funding or revenue sources. These disclosures should include both a discussion of support received from donors as well as fee-for-service activities.

Estimates/certain significant estimates. The use of estimates should be disclosed when both of the following criteria are met:

1. There exists a reasonable possibility that, in the near term, the estimate of the effect on the financial statements of a condition, situation, or set of circumstances that existed at the date of the financial statements will change due to one or more future confirming events.
2. The change would have a material effect on the financial statements.

If both conditions are met, then the required disclosure would include a description of the nature of the estimate and would indicate that “it is at least reasonably possible that a change in the estimate will occur in the near term.”

Current vulnerability caused by certain concentrations. Several categories of concentrations exist, including the following:

• Concentrations in the volume of business transacted with a particular grantor, contributor, customer, supplier, or lender. Dependence on particular governmental programs (federal, state, or local) should also be considered.
• Concentrations in support or revenue from particular programs, products, services, or fundraising events.
• Concentrations in the available sources of supply of materials, labor, or services, or of licenses or the rights used in the organization's operations.
• Concentrations in the market or geographic area where the organization conducts its operations.

Many not-for-profit organizations are highly dependent on a limited number of programs or contracts for a majority of their revenue. This concentration of risk is very common and these disclosure requirements should be carefully considered.

The not-for-profit organization would disclose the risks associated with the above mentioned concentrations if all of the following are met:

1. The concentration exists at the date of the financial statements.
2. The concentration makes the organization vulnerable to the risk of a near-term severe impact.
3. It is at least reasonably possible that the events that could cause the severe impact will occur in the near term.

In addition, the following specific disclosures are required for two types of concentration risks:

1. If the organization is subject to a concentration in the available source of labor, and the organization has collective bargaining agreements, the financial statements must disclose the percentage of the labor force covered under the collective bargaining agreement and the percentage of the labor force covered by an agreement that expires within one year of the financial statements.
2. If an organization has offices or operations located outside of the organization's home country, it must disclose the carrying amount of the net assets and their geographic location.

   The Metropolitan Museum is supported primarily by individual contributions and exhibit fees. Twenty percent of its operating revenue was derived from one art exhibit which ended during the fiscal year.

   The Metropolitan Museum is supported primarily by individual contributions and exhibit fees. One major contributor provided 25% of the support of the organization during the fiscal year.

   The City Day Care Center currently has a contract to provide day care services on behalf of the City of Example. Currently, this contract accounts for approximately 80% of the organization's revenues.

Going concern contingencies. If there is substantial doubt about an organization's ability to continue as a going concern for a period of time of one year beyond the statement of financial position date, the following information should be disclosed:

• Pertinent conditions and events giving rise to the assessment of the substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.
• Possible effects of such conditions and events.
• Management's evaluation of the significance of those conditions and events and any mitigating factors.
• Possible discontinuance of operations.
• Management's plans.
• Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

NOTE: In August 2014, the FASB issued ASU 2014-15 Presentation of Financial Statements—Going Concern (Subtopic 205-40) Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern to provide guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provided related footnote disclosures. Previously, these considerations were only contained in the auditing standards. ASU 2014-15 will make the considerations part of GAAP relative to the preparation of financial statements.

ASU 2014-15 provides that in preparing financial statements each year, an entity's management should evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued or are available to be issued.

ASU 2014-15 also provides that management's evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued or are available to be issued. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable (using the same definition discussed in this chapter for contingencies) that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued or available to be issued.

When management identifies conditions or events that raise substantial doubt about an entity's ability to continue as a going concern, ASU 2014-15 provides that management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. The mitigating effect of management's plans should be considered only to the extent that (1) it is probable that the plans will be effectively implemented, and, if so, (2) it is probable that the plans will mitigate the conditions or events that raise substantial doubt about the entity's ability to continue as a going concern. If conditions or events raise substantial doubt about an entity's ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management's plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

1. Principal conditions or events that raised substantial doubt about the entity's ability to continue as a going concern (before consideration of management's plans);
2. Management's evaluation of the significance of those conditions or events in relation to the entity's ability to meet its obligations;
3. Management's plans that alleviated substantial doubt about the entity's ability to continue as a going concern.

If conditions or events raise substantial doubt about an entity's ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management's plans, ASU 2014-15 provides that an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued or available to be issued. In addition, ASU 2014-15 provides that the entity should disclose information that enables users of the financial statements to understand all of the following:

1. Principal conditions or events that raise substantial doubt about the entity's ability to continue as a going concern;
2. Management's evaluation of the significance of those conditions or events in relation to the entity's ability to meet its obligations;
3. Management's plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity's ability to continue as a going concern.

ASU 2014-15 is effective for annual periods ending after December 15, 2016, with early application permitted.

Guarantees. A guarantor should disclose the following information about each guarantee, or each group of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote:

• The nature of the guarantee, including the appropriate term of the guarantee, how the guarantee arose, and the events and circumstances that would require the guarantor to perform under the guarantee.
• The maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee, not netted by any potential recoveries. If there is no maximum amount, that fact should be disclosed. Special rules apply to product warranties.
• The current carrying amount of the liability, if any, for the guarantor's obligations under the guarantee, regardless of whether the guarantee is freestanding or embedded.
• The nature of (1) any recourse provisions that would enable the guarantor to recover from third parties any of the amounts paid under the guarantee, and (2) any assets either held as collateral or by third parties that, upon the occurrence of any triggering event or condition under the guarantee, the guarantor can obtain and liquidate to cover all or a portion of the amounts paid under the guarantee.

For guarantees involving related parties, these disclosures are in addition to related party disclosures contained in FASB ASC 850-10.