Objective

This document provides guidance on the issues surrounding the accounting for the liability for contingent liabilities stemming from claims and litigation.  Guidance on accounting for contingent liabilities stemming from loan guarantees and contaminated sites is available separately.  Guidance on the treatment of contingent recoveries/gains stemming from claims and litigation is found at the end of this document.

References

TBAS 3.6 – Contingencies

PS 3300 – Contingent Liabilities

Background

Section 64 of the Financial Administration Act requires that the Public Accounts of Canada include the Government's contingent liabilities.  Additionally, Section 63 states that a reserve for contingent liabilities should be established as required to present fairly the financial position of Canada.

Contingent liabilities are potential liabilities which may become actual liabilities when one or more future events occur or fail to occur.  In determining the proper accounting treatment for contingent liabilities, the following two elements are required:

  1. An assessment of the likelihood of an adverse outcome for the Government; and
  2. An estimate of potential liability.

(i) Likelihood of an adverse outcome

Justice Canada has developed the following scale for assessing the likelihood of adverse outcome:

Likely
greater than 70% chance of adverse outcome
Medium
between 30% and 70% chance of adverse outcome
Unlikely
less than 30% chance of adverse outcome
Unable to assess
insufficient information to assess the likelihood of adverse outcome

(ii) Estimate of potential liability

This amount represents legal counsel's best estimate of potential loss to the Government based on precedent, probability analysis or other considerations.  The estimate of potential liability should include an assessment of damages, plaintiff's legal costs and interest.  The estimate should exclude any costs the Government will incur in defending against the claim such as legal costs and other professional fees.  A range of potential liabilities may be developed.  When a particular amount within such a range appears to be a better estimate than any other, that amount would be reported.  However, when no amount within the range is indicated as a better estimate than any other, the minimum amount in the range would be reported.

Note: the estimate of contingent liability should reflect the best estimate of the potential liability based on information available as at the reporting date.  It is expected that there will be fluctuations in the estimates as additional information becomes available. Individual estimates of contingent liabilities do not affect a department's future requests for funding to settle the claim.

Accounting for contingent liabilities

The accounting treatment depends on the assessment of the likelihood of adverse outcome.

Likely
Contingent liabilities that are assessed as likely to result in an adverse outcome and which can be estimated are totalled and recorded as an estimated liability. No disclosure is provided of either the individual estimates or the total amount of the allowance. In the case where an accrual is recorded but only covers a portion of the estimated range of liability, the difference between the amount recorded and the top of the range should be considered for disclosure in the notes to the financial statements.
Medium or unable to assess (i.e. not determinable)
Contingent liabilities where the likelihood of an adverse outcome is assessed as medium or where the likelihood cannot be determined and for which a potential liability has been estimated are totalled and disclosed in the notes to the department's financial statements.  The fact that the estimate covers only a portion of all claims against the Government is also disclosed.
Unlikely
Contingent liabilities that are assessed as unlikely to result in an adverse outcome are provided no accounting treatment.

Why an estimate of contingent liability is important?

The estimate of contingent liability significantly affects the reporting of contingent liabilities.  For cases assessed as likely to be lost, the absence of an estimate means than an allowance cannot be recorded in the financial statements.  As a result, the fair presentation of the financial statements can be affected where significant cases or large volumes of cases are lacking estimates.

For cases assessed as medium or where an assessment cannot be made, the disclosure of contingent liabilities is based on the best estimate of possible liability.  Due to the volume of claims against many departments it is not possible to provide a qualitative description of each of the claims facing the department.  As a result, where estimates are lacking, the effectiveness of the disclosure of contingent liabilities is severely reduced

Application

Departments are to record an estimated liability for a claim once it is assessed as likely to result in a liability and it can be reasonably estimated.  However, the following two exceptions apply:

In these situations, the accounting treatment in the departmental financial statements should be limited to note disclosure.  Departments are to identify the unrecorded liability as part of their response to the annual call letter for the valuation of assets and unrecorded liabilities.  The liability and related expense stemming from these claims would be recorded in the consolidated financial statements.  A department will record the expense and liability in their accounts once the uncertainty surrounding the liability is removed (for example, a court decision is rendered or a settlement agreement is announced).

Note: Where more than one department is named in a claim, departments are to report an estimate of their share of the contingent liability.  The estimated division of the potential liability should be based on advice from legal counsel and management as to how the liability might be assigned.

Scenario 1- Claim assessed as likely to result in a financial loss.

During the quarterly update of the status of its contingent liabilities, the legal assessment of one claim is changed from not determinable to likely. The estimated liability is $20,000.

  AMT($) FRA AUTH OBJ
DR Operating expenses or
Miscellaneous expenses special payments 
20,000 51321/
51722
F128 3469
CR Allowance for contingent liabilities  20,000 21433 R300 7029

Note that the above entry would be recorded each time the estimate of loss is increased over the years (for example to include another year's interest on the balance).

FRA Coding Rationale
The estimated expense related to a claim or threatened litigation is recorded by debiting the FRA appropriate to the nature of the expense.  As a general rule, the FRA will be either 51321 – Operating expenses or 51722 Miscellaneous expenses special payments; however, other FRAs may be appropriate in specific cases.  The liability would be recorded by crediting FRA 21433 – Allowance for contingent liabilities.
Authority Coding Rationale
The recording of the estimated liability does not affect appropriations since an expenditure has not occurred at this point. "F128 – Expenses related to claims and litigation" is used for the expense while "R300 – All other assets and liabilities" is used for the liability.
Object Rationale
"3469 – Charge to other liability account" should be used to record the expense while "7029 – Allowance for valuation of assets and liabilities – other allowances" should be used to record the allowance.

2 – Confirmation that loss has occurred

Scenario 2A:  Department either loses the court decision or settles out-of-court with the plaintiff (say $40,000).

To charge amount to vote:

  AMT($) FRA AUTH OBJ
DR Operating expenses or
Miscellaneous expenses special payments
40,000 51321/
51722
A/B(*) 32xx
CR Accounts Payable  40,000 21111 R300 6299

To reverse accrued liability:

  AMT($) FRA AUTH OBJ
DR Allowance for contingent liabilities 20,000 21433 R300 7029
CR Operating expenses or
Miscellaneous expenses special payments 
20,000 51321/
51722
F128 3469

Note that the coding in these entries remain the same regardless of the amount of the final liability.  For example if the final liability was $10,000, this amount would appear in the first entry but $20,000 would remain in the second entry.

The rationale for the first accounting entry is:

FRA Coding Rationale
The expenditure related to a claim or threatened litigation is recorded by debiting the FRA appropriate to the nature of the item. The same FRA debited in scenario 1 should be debited.  The Department records a payable for the amount owing by crediting FRA 21111 – Accounts Payable.
Authority Coding Rationale
The appropriate vote to charge will depend on the claim however in most cases the expenditure should be charged to the department's operating vote. Since accounts payable has no impact on appropriations, R300 is used.
Object Rationale
On the expense line, the appropriate econ should be used.  For example, "3249 – Court awards to industry", "3250 – Court awards to persons", "3251 – Damage and other claims against the Crown", or other as appropriate.  "6299- Net Increase or Decrease to Other Liability accounts" should be used to indicate the establishment of the accrued payable.

The second accounting entry is the reversal of the codes used to establish the liability in Scenario 1.

Scenario 2B: Department wins the court decision or there is no financial liability resulting from the settlement.

The only required entry is the reversal of the accrued liability:

  AMT($) FRA AUTH OBJ
DR Allowance for contingent liabilities 20,000 21433 R300 7029
CR Operating expenses or
Miscellaneous expenses special payments
20,000 51321/
51722
F128 3469

Note that an estimated liability that is recorded for a contingent liability should only be derecognized when it is settled of otherwise extinguished, or when it is determined that the existence of a liability at the financial statement date is unlikely.  De-recognition should not occur as a result of the likelihood of the future confirming event becoming undeterminable.  For example, say the decision to accrue an estimated liability was based on the fact that a similar claim has been lost in the past.  If subsequent to the accrual, the decision in the earlier claim is overturned or another court decision reduces the likelihood of a loss in this case, the accrued liability would not be reversed until resolution of the claim or the likelihood of loss becomes unlikely (i.e. less than 30% chance of the department losing).  This accounting treatment is consistent with the accounting concept of conservatism.

Quarterly Reporting of Contingent Liabilities

From a financial management perspective, contingent liabilities represent a risk that the department should monitor closely as they may result in future financial requirements.  From a broader perspective, monitoring contingent liabilities relating to claims and threatened litigation is important as they may be an indication that corrective action is required in the department's activities.  For example, claims may result from inappropriate procedures or activities, or miscommunications.  The preparation of quarterly reports on claims and pending and threatened litigation (i.e. Plate I-12) for submission to the Receiver General is designed to ensure that departments perform at least a quarterly review of the cases and to provide information to the central agencies on the contingent liabilities facing the Government.

Departments should use the fourth quarter report, as at March 31st, as the basis of their year-end entries to CFMRS.  The year-end cut-off for CFMRS does not permit the use of the final contingent liabilities report, as at April 30th, for accounting purposes.  Where an event occurs subsequent to the CFMRS year-end cut-off which results in a significant financial impact for the department, such as the loss of a claim that was previously not considered likely to be lost, the department should communicate this fact to TBS for possible recording in the central accounts.  The department should also reflect the financial impact in their financial statements as if the event had occurred prior to March 31st (refer to PS 2400 Subsequent Events, specifically the treatment of events that provide further evidence of conditions which existed at the financial statement date).

Information on Contingent Recoveries (Gains)

Contingent recoveries or gains are possible future inflows of economic benefits arising from existing conditions or situations involving uncertainty.  Examples of contingent recoveries include potential recoveries of conditionally repayable contributions (CRCs) and potential settlements in litigation claims launched by a department.  The accounting treatment for CRCs is found in section 9.8.1 of the FIS Accounting Manual.

Disclosure of a contingent recovery which is considered likely to be realized and is material should be included in a note to the financial statements. Particular care should be exercised in the disclosure of contingent recoveries to avoid a misleading implication as to the likelihood of realization.

Contingent recoveries/gains are to not to be recognized as an asset until the uncertainty surrounding the existence of a recovery is lifted.  For example, in the case of a claim launched by a department seeking financial compensation, an accounts receivable would only be recorded following the signing of an out-of-court agreement or a ruling by the court in favour of the department.  The accounting entry will depend upon the nature of the recovery/gain (e.g. recovery of expense, recognition of revenue) and should be tailored to the specific circumstances. No note disclosure of the contingent recovery/gain is required prior to the point of recognition of the receivable.  If the department's ability to collect the receivable is in doubt, including situations where the decision is being appealed, the department should record an allowance for doubtful accounts.

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