Darren Company becomes aware of a lawsuit after the date of the financial statements, but before they are issued. A loss and related liability should be reported in the financial statements if the amount can be reasonably estimated, an unfavorable outcome is highly probable, and
A) the Darren Company admits guilt.
B) the court will decide the case within one year.
C) the damages appear to be material.
D) the cause for action occurred during the accounting period covered by the financial statements.

Question

Quizplus · Accepted Answer

The key factor for recognizing a liability for a lawsuit in financial statements is that the cause for action (the event leading to the lawsuit) must have occurred during the accounting period covered by the financial statements. This is in line with the matching principle and the accrual basis of accounting, which require expenses to be recognized in the period in which the related revenues are earned or the period in which the event that causes the expense occurs, regardless of when the cash is paid.

Darren Company Becomes Aware of a Lawsuit After the Date