Harvard University Policy:

Accounting for Contingencies

University Policy Overview:

Contingencies are potential liabilities. Depending on the circumstances of a specific event (for example, pending lawsuits), the University may have to account for or disclose in its financial statements any contingency that will result in a loss. Gain contingencies are not recorded in the accounts, but are disclosed in the notes to the financial statements.

The reserves for contingencies policy establishes the guideline to properly account for contingencies in compliance with the Financial Accounting Standards Board (FASB).

In accordance with FASB's Statement of Financial Accounting Standards No. 5 (Accounting for Contingencies) when information becomes available before the financial statement's issuance that indicates that it is: 1) probable that an asset has been impaired or a liability has been incurred and 2) the amount of the loss is reasonably estimated, the contingency should be recognized in the accounts.

If the specific event does not meet both conditions stated in #1 and #2 above, any material contingency is recorded in the notes to the financials.

For financial statement and government reporting, this policy covers the University's compliance with SFAS No.5, by accounting for "Reserves for Contingencies."

A contingency is an existing condition, situation, or set of circumstances involving varying degrees of uncertainty that may, through one or more related future events, result in a gain or loss to the University that will ultimately be resolved when one or more future events occur or fail to occur.

Resolution of the uncertainty may lead to the acquisition of an asset, the reduction of a liability, loss or impairment of an asset, or the occurrence of a liability.

Determining Loss Contingencies

A) Loss contingencies may arise from the risk of exposure resulting from, but not limited to the following:

• Pending or threatened litigation, claims or assessments

• Guarantees of indebtedness of others

• Obligations of commercial banks under standby letters of credit

• Uncollectible receivables

• Obligations related to service warranties and defects

B) When loss contingency exists, the likelihood that the future event or events will confirm the incurrence of a liability can range from probable to remote.

Three terms or phrases are used to identify the areas within that range, which include:

• Probable - the future event or events are likely to occur

• Reasonably Possible - the chance of the future event or events occurring is more than remote, but less than likely

• Remote - the chance of the future event or events occurring is slight

C) An estimated loss from a contingency should be accrued by a charge to expense and a liability recorded only if both of the following conditions are met:

• Information available prior to the issuance of the financial statement indicates that it is probable that a liability has been incurred at the date of the financial statements.

• The amount of the loss can be reasonably estimated.

• The amount is material.

Accounting for Loss Contingencies

A) Depending on the classification of the contingency and assuming that the loss is material, the loss may be:

• Accrued as an expense as of the date of the financial statements and disclosed (probable and estimable)

• Disclosed in the notes to the financial statements but not accrued (reasonably possible)

• Neither accrued nor disclosed (remote)

B) Material loss contingencies accrued ordinarily require footnote disclosure so that financial statements are not misleading. The disclosure should consist of the nature of the contingency and the amount accrued.

C) If one or both conditions for accrual of a loss contingency are not met and the loss contingency is classified as probable or reasonably possible, the financial statement disclosure of the loss contingency is required.

The disclosure should contain the description of the nature of the loss contingency and the range of possible loss, or include a statement that no estimate of the loss can be made.

The following factors, among others must be considered when determining whether a liability should be recorded with respect to pending or threatened litigation and actual or possible claims and assessments:

• Period in which the underlying cause for action occurred

• Degree of probability of an unfavorable outcome

• Ability to make a reasonable estimate of the amount of the loss

Accounting for Gain Contingencies

 

Material gain contingencies should be disclosed in the financial statements by note, but should not be reflected in income, because doing so may result in recognizing revenue prior to realization. Care should be exercised in disclosing gain contingencies in order to avoid misleading implications as to recognition of revenue before its realization.

 

The Office of Financial Systems is responsible for writing, updating, and interpreting this policy.

The Financial Deans of the University are responsible for having their school's financial management reviewed by the Director of Financial Systems.

For assistance in interpreting this policy, please call your Tub Financial Office.