Which of the following is a contingent liability that must be disclosed in the financial statements?

• A. Accounts payable to suppliers
• B. A fully insured asset
• C. Common stock issued to shareholders
• D. A pending lawsuit with a reasonable possibility of loss

Answer: (D)

Verified step by step guidance

1. Understand the concept of contingent liabilities: A contingent liability is a potential obligation that may arise depending on the outcome of a future event. It is not recorded as a liability on the balance sheet unless it is probable and the amount can be reasonably estimated. However, it must be disclosed in the financial statements if there is a reasonable possibility of loss.
2. Analyze the options provided: Accounts payable to suppliers is a current liability that is already recorded in the financial statements. A fully insured asset does not represent a liability. Common stock issued to shareholders is equity and not a liability.
3. Focus on the pending lawsuit: A pending lawsuit with a reasonable possibility of loss fits the definition of a contingent liability. It is not certain but has the potential to result in a financial obligation depending on the outcome of the lawsuit.
4. Determine the disclosure requirement: Since the pending lawsuit has a reasonable possibility of loss, it must be disclosed in the financial statements to inform users about the potential risk and its impact on the company’s financial position.
5. Conclude that the correct answer is the pending lawsuit with a reasonable possibility of loss, as it meets the criteria for a contingent liability that requires disclosure in the financial statements.