If a loss contingency related to a lawsuit against a firm is deemed to have a high probability of requiring ultimate payment and can be reasonably estimated, then the proper accounting treatment of the loss contingency will
A)decrease the debt/equity ratio.
B)decrease the debt/asset ratio.
C)decrease earnings per share.
D)increase net income.

Question

Quizplus · Accepted Answer

When a loss contingency related to a lawsuit is deemed to have a high probability of requiring ultimate payment and can be reasonably estimated, it is recorded as a liability on the company's balance sheet and a corresponding expense on its income statement, which decreases earnings per share. This indicates to investors that the company may experience financial difficulties in the future, which can have a negative impact on its stock price. Therefore, option C is the correct answer. The other options are not relevant to the accounting treatment of loss contingencies.

If a Loss Contingency Related to a Lawsuit Against a Firm