Topic C - Posted Thursday Consider This Example Of The Full

Topic C - posted Thursday Consider this example of the Full Disclosure principle

Consider this example of the Full Disclosure principle: A train derails and causes significant personal and property damage. At year end, claims are still being filed by the injured parties and there are quite a few lawsuits asking for outrageous money. 1) Would you accrue a "contingent" liability for any of the probable payouts in the future? 2) How would you go about estimating the potential liability from this incident? 3) The Footnotes to the financial statements are also a form of disclosure. Should any amount not be accrued and only disclosed in the footnotes? 3) Why bother?

Paper For Above instruction

The Full Disclosure principle is a fundamental concept in accounting that mandates companies to reveal all material information that could influence users' decisions. This principle ensures transparency and accountability in financial reporting by requiring companies to disclose not only the financial statements but also additional relevant details that might affect stakeholders' understanding of the company's financial position and performance. The example involving a train derailment illustrates the application of this principle and raises specific questions about contingent liabilities, estimation of liabilities, and disclosures in footnotes.

Firstly, regarding whether to accrue a contingent liability for probable future payouts, the answer largely depends on the likelihood and estimability of the liability. According to accounting standards such as Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), a liability should be recognized when it is both probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and the amount can be reliably estimated (FASB, 2014; IASB, 2018). In the case of the train derailment, if at year-end it is probable that claims will be filed and that settlements will be made, and if the amount can be reasonably estimated, then a provision or accrual should be recognized. However, if the amount remains uncertain and estimation is difficult, it may not be appropriate to accrue immediately but rather disclose the contingent liability.

Secondly, estimating the potential liability involves a combination of legal, actuarial, and engineering assessments. Companies often consult with legal advisors to assess the probability of claims being successful, while actuarial techniques help estimate the range of possible payouts based on similar past incidents and claim history. Engineering evaluations might also be relevant if specific damages can be quantified. Techniques such as Monte Carlo simulations, scenario analysis, and other statistical methods are employed to derive an estimate that reflects the best approximation of expected liabilities (IFRS Foundation, 2018). The goal is to present a reasonable estimate that aligns with the concept of faithful representation in financial reporting.

Thirdly, concerning disclosure in footnotes versus accrual in the financial statements, the distinction is crucial. Certain contingent liabilities, especially those that are possible but not probable, or where the amount cannot be reliably estimated, are not recognized on the balance sheet but are disclosed in the footnotes. Footnote disclosures serve to inform users of potential obligations that are significant but do not meet the recognition criteria. For example, if at year-end the likelihood of claims being settled is only reasonably possible rather than probable, then the company should disclose this in the footnotes rather than accrue a liability. This approach aligns with the concept of full disclosure, which aims to keep financial statement users informed about potential risks and uncertainties affecting the company (SEC, 2020).

Finally, the rationale behind these disclosure practices is to maintain transparency and enable investors, creditors, and other stakeholders to make informed decisions. Not accruing a liability but disclosing it in footnotes is justifiable when the uncertainty is high, and the amount cannot be reliably estimated. It prevents overstating liabilities, which could mislead users about the company's financial health. Conversely, disclosure in footnotes provides necessary context and details that might impact an organization's valuation or risk assessment, ensuring compliance with the full disclosure principle (Brown & Tucker, 2017). Hence, a balanced approach that combines recognition of liabilities where appropriate with comprehensive disclosure is vital for faithful financial reporting.

References

• Financial Accounting Standards Board (FASB). (2014). Accounting Standards Codification (ASC) Topic 450 — Contingencies.
• International Accounting Standards Board (IASB). (2018). IFRS Standards — IAS 37 Provisions, Contingent Liabilities, and Contingent Assets.
• IFRS Foundation. (2018). International Financial Reporting Standards (IFRS) — Basis for Conclusions.
• Securities and Exchange Commission (SEC). (2020). Regulation S-X and Staff Accounting Bulletin No. 5.
• Brown, R., & Tucker, J. (2017). Financial Accounting and Reporting: An International Approach. McGraw-Hill Education.
• Barth, M. E., & Landsman, W. R. (2010). How Did Financial Reporting and Auditing Change During the 20th Century? Journal of Accounting and Economics, 50(2-3), 221-268.
• Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and Analysis: Text and Cases. John Wiley & Sons.
• Jonsson, A., & Olsson, A. (2017). Disclosure and Transparency in Financial Reporting. Journal of Business Economics, 87(4), 449-473.
• Horrigan, J. (2018). Fundamentals of Financial Accounting. Routledge.
• Faber, R. J., & O'Reilly, T. (2017). The Importance of Transparency in Financial Reporting. Harvard Business Review.