Which statement is true of contingency reserves in financial accounting?

• A. Contingency reserves are not recognized as liabilities until the occurrence of a future event is probable and the amount can be reasonably estimated.
• B. Contingency reserves must be recognized for all possible future losses, regardless of probability.
• C. Contingency reserves are only disclosed in the notes if the loss is remote.
• D. Contingency reserves are always recorded as assets on the balance sheet.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of contingency reserves. Contingency reserves are amounts set aside to cover potential future liabilities or losses that may arise due to uncertain events.
2. Step 2: Review the criteria for recognizing liabilities in financial accounting. According to accounting standards, a liability is recognized when the occurrence of a future event is probable and the amount can be reasonably estimated.
3. Step 3: Analyze the options provided in the problem. Evaluate each statement to determine its accuracy based on the definition and recognition criteria for contingency reserves.
4. Step 4: Note that contingency reserves are not recognized as liabilities unless the future event is probable and the amount can be reasonably estimated. If the likelihood of the event is remote, the reserves are disclosed in the notes to the financial statements rather than being recorded.
5. Step 5: Eliminate incorrect statements, such as those suggesting contingency reserves are always recorded as assets or must be recognized for all possible future losses regardless of probability. Focus on the correct statement that aligns with accounting standards.