A gain contingency is an unclear circumstance that could result in a gain when it is resolved in the future. The accounting standards forbid the recognition of a gain contingency before the underlying event has been resolved. Doing so could lead to the recognition of income too soon (which violates the conservatism principle). Instead, a gain cannot be realized until the underlying ambiguity has been resolved.
It is acceptable to describe the type of contingency in the notes that accompany the financial statements if it has the potential to result in a gain. Therefore, no potentially false claims about the likelihood of realizing the contingent gain should be included in the disclosure. A reader of the financial statements would come to the conclusion if this were to happen that a gain would soon be realized.
Gain contingencies include, for instance, receiving money as a result of donations, bonuses, or other presents. Another example of a gain contingency is a future lawsuit that will be won by the corporation. This can include anticipated government returns related to tax issues.
The potential gain from a gain contingency is not recorded in accounting since the exact amount is unknown. If the gain is anticipated to be large, it can be mentioned in the financial statement's notes. About the ramifications of a projected gain contingency, businesses must take care not to make deceptive representations.
The entity must decide whether to include a gain contingency in the footnotes of a financial statement. The likelihood that the benefit contingency will materialize should be taken into account when making the decision. Reporting gain contingencies in the footnotes of financial statements may have benefits, such as providing investors with crucial information regarding prospective gains the company may soon realize.
A loss contingency is a similar uncertain condition as a gain contingency. Unknown future circumstances could result in a corporation suffering financial loss. But, unlike gain contingencies, loss contingencies, if probable, should be disclosed by debiting a loss account and crediting a liability account. Reporting the contingency's nature and the approximate amount of money involved is required.
A small, local design firm called Zebra Inc. focuses on captivating black and white visuals. A sizable, reputable, and global design firm called Lion Co. takes what it wants when it wants. Zebra sued Lion for $10 million, claiming that Lion engaged in aggressive business practices by allegedly stealing many of Zebra's designs without its consent. According to the attorneys for both businesses, Zebra will prevail in the lawsuit at the end of the year, giving it a 75–80% likelihood of success. Also, Lion's attorneys anticipate that Lion will pay between $4.5 million and $8.5 million to resolve the complaint in the upcoming year.
How should Zebra adjust their year-end U.S. GAAP financial statements to accommodate for this possibility?
Zebra shouldn't budget any money for the legal battle with Lion gain contingencies according to ASC 450-30-25-1.
The financial statements typically shouldn't include a contingency that could result in a gain because doing so could result in the recognition of revenue before it really occurs.
Gain contingencies, however, might be reported in the financial statements' comments, but they shouldn't be included in income until they are actually realized. Gain contingencies should be disclosed with caution to prevent giving the wrong impression that income is recognized before it is actually realized. Zebra should therefore be transparent about its legal dispute with Lion, which is expected to have a positive outcome the following year.