A company is a defendant in a lawsuit and its lawyers assess the likelihood of an unfavorable outcome requiring payment as 60 percent, with the amount reasonably estimable. Under IAS 37, and separately under US GAAP (ASC 450), is this contingency recognized as a liability on the balance sheet, or only disclosed in the notes?
- Under both IAS 37 and ASC 450, the contingency is recognized as a liability because 60 percent exceeds each framework's identical probability threshold
- Under ASC 450, a liability is recognized because 60 percent exceeds its threshold; under IAS 37, the item is only disclosed because IAS 37 sets its threshold above 60 percent
- Under IAS 37, a provision is recognized because 60 percent exceeds the standard's more-likely-than-not threshold; under ASC 450, the item is generally only disclosed, because US GAAP's probable threshold is commonly applied at a materially higher likelihood than 60 percent
- Under both IAS 37 and ASC 450, the contingency is only disclosed in the notes, because 60 percent is below both frameworks' recognition thresholds
Why C? And why not the others?
Correct answer: C. Under IAS 37, a provision is recognized because 60 percent exceeds the standard's more-likely-than-not threshold; under ASC 450, the item is generally only disclosed, because US GAAP's probable threshold is commonly applied at a materially higher likelihood than 60 percent
IAS 37 requires a provision to be recognized when an outflow of resources is probable, and the standard defines probable as more likely than not to occur, which is commonly applied as a threshold just above 50 percent; a 60 percent likelihood clearly clears that bar, so a provision is recognized together with a reasonable estimate of the amount. ASC 450 also uses the word probable as its recognition threshold, but in practice that threshold is applied at a materially higher likelihood, often described as roughly 75 to 80 percent or higher, so a 60 percent likelihood, while indicating a real possibility of loss, typically falls into the reasonably possible category that leads to disclosure in the notes rather than recognition of a liability. The option finding recognition under both frameworks is wrong because it assumes the two frameworks apply an identical numeric threshold, when the practical application of the probable threshold differs meaningfully between them. The option finding disclosure only under both frameworks is wrong because it understates IAS 37's lower more-likely-than-not threshold, which 60 percent satisfies. The option reversing the two frameworks' outcomes is wrong because it attributes the lower threshold to US GAAP and the higher threshold to IFRS, which is the opposite of how each standard is actually applied in practice.
Source: IFRS Foundation, IAS 37 Provisions, Contingent Liabilities and Contingent Assets, paragraphs 14 and 23 (probable defined as more likely than not); FASB Accounting Standards Codification ASC 450-20 Loss Contingencies (probable threshold applied at a materially higher likelihood in practice)