Two small retail customers filed lawsuits against the company in 2009 alleging misrepresentation, breach of contract, conspiracy to violate federal laws, and state antitrust violations related to their purchase of retail grocery stores through the company from a third party. The lawsuits seek actual and treble damages up to $10 million each, as well as punitive damages of $2 million in one suit and $10 million in the other. The company is vigorously defending the actions and believes there will be no adverse financial effect.

1. Assume the following note appeared in the annual report of a company:
In 2009 , two small retail customers filed separate suits against the company alleging
misrepresentation, breach of contract, conspiracy to violate federal laws, and state antitrust
violations arising out of their purchase of retail grocery stores through the company from a third
party. Damages sought range up to USD 10 million in each suit for actual and treble damages
and punitive damages of USD 2 million in one suit and USD 10 million in the other. The
company is vigorously defending the actions and management believes there will be no adverse
financial effect.
What kind of liability is being reported? Why is it classified this way? Do you think it is possible
to calculate a dollar amount for this obligation? How much would the company have to pay if it
lost the suit and had to pay the full amount?
Solution
Such a liability is called "Contingent Liability"
Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome
of a uncertain future event such as a court case. These liabilities are not recorded in a company's
accounts and shown as footnote to the balance sheet with the probable amount that company
might be liable to incase of unfavourable decision.
It is classified this way because of the lack of certainity of amount and the probability of the
event occuring. It do not impact the current financial position of the company. That is why it is
shown in the footnote.
Exact estimation of loss is not possible however an approximate value which is calculated
"being prudent" can be shown as contingent liability.
Company incase of loosing the suit will have to pay the actual damages ($10 mn each X 2 suits =
$20 million) + punitive damages of $2mn and $10mn. Total amount is $32mn.