Why might the accounting value and economic value of contingent liabilities such as warranties or lawsuits differ?
Got this in an interview question and couldn't really answer. Said something along the lines of disclosing the real amount in a lawsuit would give the opposition an advantage ..
There might be a more sophisticated answer to this but I would think it's just be that the liability reported for accounting purposes depends on managements perception of the likelihood of a loss being realized and estimation of the amount of the loss, which could differ significantly from what the loss actually turns out to be.
And yes you're right companies have a disincentive in disclosing their actual estimate as this can be seen as basically admitting to what they owe in trying the case.
You can have contingent liabilities (e.g., guarantees) that are off-balance sheet and therefore have no accounting value but actually do have an economic value (equal to the expected value of the liability).
You could also have liabilities that are held at historical cost, like debt, that are not accounted for at their fair market value.
Under GAAP, a contingent liability is only booked if it is probable and the value can be reasonably estimated. If there's a 50% chance that you'll lose a lawsuit for $1M, you have a $1M liability. If you claim you only have a 25% chance of losing the lawsuit, it shows up in the footnotes and has no "accounting value", as I interpret the question. If a liability is likely to occur but you don't have a good estimate of the value, it still has 0 accounting value, and you report a range in the notes.
No idea what economic value means. I'm an accounting student.
Haha, this is great.
"No idea what economic value means. I'm an accounting student."
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