What Is a Loss Contingency?
Contingent liability accounting under US GAAP runs through ASC 450-20, which accrues a loss only when it is probable and reasonably estimable. ASC 450-20-25-2 sets both conditions. Information available before the financial statements are issued has to indicate that a liability had been incurred at the balance sheet date, and the amount of the loss has to be capable of reasonable estimation.
Both, not either.
When only one condition holds, the exposure gets disclosed rather than accrued. The loss contingency ASC 450 framework hasn’t changed in 50 years. ASC 450-20 is the recodification of FASB Statement No. 5, Accounting for Contingencies, issued in March 1975. There’s no newer and softer guidance waiting to be found.
Four things the definition requires:
- The condition already exists. A contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss that resolves when future events occur or fail to occur.
- It exists at the balance sheet date. An exposure created by an event after that date is a subsequent event question under ASC 855, not a current-period accrual.
- Estimability can arrive late. A loss that was probable at the balance sheet date but becomes estimable only later is charged to income in that later period. It isn’t restated back.
- Likelihood runs on a three-point scale. ASC 450-20-25-1 frames the confirming future event as probable, reasonably possible, or remote.
If the books are still being brought fully onto accrual, the contingency register tends to be the last piece built. Our guide to GAAP accounting for startups covers the rest of that groundwork.
The Probable, Reasonably Possible, Remote Scale
GAAP’s three likelihood terms come straight from the ASC master glossary, and not one of them carries a number.
- 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.
The definitions are deliberately qualitative. Practitioner shorthand that puts probable at 70% or 75% comes from exam-prep material, not from the standard. The AICPA’s own journal makes the same point in its treatment of sales and use tax loss contingencies. A defensible conclusion is built from counsel’s assessment, settlement history in comparable matters, and the stage of the proceeding.
Two labeling rules reviewers catch. ASC 450-20-50-1 prohibits the word reserve for an accrual made under ASC 450-20-25-2, so use estimated liability or similar descriptive terminology. ASC 450-20-50-2 then requires you to indicate, when the ASC 275-10-50-8 criteria are met, that the estimate of a probable liability could change in the near term.
Gain contingencies are asymmetric. ASC 450-30-25-1 provides that a contingency that might result in a gain usually is not reflected in the financial statements, because that risks recognizing revenue before realization. The bar for a gain is realized or realizable, higher than probable and estimable. So the settlement you expect to win stays off the balance sheet, while the mirror-image loss on the other side of the same dispute sits there as an accrued expense.
Accrue, Disclose, or Stay Silent
When to accrue a legal settlement, a tax assessment, or a warranty claim comes down to the two tests applied together. Here’s the grid, with the paragraph behind each cell.
| Likelihood | Estimable | Treatment |
|---|---|---|
| Probable | Yes | Accrue under ASC 450-20-25-2 and disclose the nature of the accrual under ASC 450-20-50-1 |
| Probable | No | No accrual. Disclose under ASC 450-20-50-3 and 50-4, stating that an estimate cannot be made, which ASC 450-20-50-5 treats as preferable to accrual |
| Reasonably possible | Yes | No accrual. Disclose the nature plus the estimate or the range |
| Reasonably possible | No | No accrual. Disclose the nature plus a statement that no estimate can be made |
| Remote | Either | No accrual, no ASC 450 disclosure. Guarantees inside ASC 460 are the exception and get disclosed even when performance is remote |
ASC 450-20-50-3 is the trigger and ASC 450-20-50-4 is the content, so treat them as a pair. “Our attorney won’t give us a number” isn’t a reason to say nothing. It’s the reason the standard accepts a statement that no estimate can be made.
Silence is not on the menu.
One misread is worth clearing up. Aggregating similar contingencies by class, rather than disclosing matter-level dollar detail, is accepted practice that SEC staff has not objected to. It’s an accommodation on the level of detail, not a codified rule, and ASC 450 carries no tabular rollforward requirement. That one lived in a 2010 FASB proposal the Board dropped in July 2012.
Measuring a Loss Inside a Range
ASC 450-20-30-1 governs measurement once accrual is required. If some amount within the range is a better estimate than any other, accrue that amount. When none is, accrue the minimum. The standard’s reasoning is that the minimum isn’t necessarily the ultimate loss, but the ultimate loss is unlikely to come in below it.
The minimum, not the midpoint.
The midpoint belongs to IFRS. IAS 37 paragraph 39 provides that where there is a continuous range of possible outcomes and each point in that range is as likely as any other, the mid-point of the range is used. On a range of $400,000 to $1,000,000 with no better point estimate, a US filer accrues $400,000 and an IFRS filer provides $700,000. A company with a European lead investor will hear both numbers from different advisors, and both are right under their own framework.
Accruing the minimum doesn’t close the file. Exposure now exists in excess of the amount accrued, which triggers ASC 450-20-50-3, so the additional $600,000 up to the top of the range gets disclosed.
Legal Fees and Expected Recoveries
Legal defense costs are an accounting policy election. ASC 450-20-S99-2, an SEC staff announcement originating in a January 1997 EITF discussion, treats legal costs expected to be incurred in connection with a loss contingency as a policy choice that has to be applied consistently and disclosed. Two approaches are permitted:
- Accrue estimated future defense costs when the loss contingency is recognized.
- Expense defense costs as incurred, which is what most companies choose, because forecasting fee burn to the precision ASC 450 demands is hard.
Make the election and document it before the first material matter arises, not in a negotiation with your auditor afterward.
Expected recoveries get recognized separately and never netted. ASC 720-20-45-1 prohibits offsetting a receivable for an expected insurance recovery against a recognized liability unless the ASC 210-20-45-1 right of setoff is satisfied, and an insurance claim fails that test on the first condition, because the counterparties differ. The insurer owes you. You owe the plaintiff. Four rules follow:
- Recognize the receivable only when realization of the claim is probable.
- Cap it at the lesser of the recognized loss or the probable recovery.
- Treat any recovery above the recognized loss as a gain contingency under ASC 450-30, unrecognized until realized.
- Apply a rebuttable presumption that realization is not probable when the claim is disputed or in litigation. That position comes from ASC 410-30-35-8 and SEC staff views at SAB Topic 5-Y, applied by analogy outside the environmental context.
SaaS-Specific Application
The sales tax exposure accrual, not a lawsuit, is the ASC 450 matter most growth-stage SaaS companies are actually carrying.
Start with the right model. ASC 740-10-15-3 limits ASC 740 to domestic federal income taxes and to foreign, state, and local taxes based on income, including some franchise taxes. Sales and use tax, payroll tax, property tax, and VAT sit outside that scope. An uncertain income tax position runs through the ASC 740-10 two-step model. An uncollected sales tax exposure runs through ASC 450-20-25-2. Different models, different thresholds, routinely conflated.
Three exposures recur at $1M to $20M revenue:
- Uncollected sales tax in states where economic nexus was crossed years before anyone looked.
- Worker classification, where contractors have been treated as non-employees without a documented basis.
- Customer indemnities under enterprise contracts, including IP infringement, data breach, and tax gross-up clauses.
What makes these harder than litigation is that sizing them takes two skill sets at once. The revenue-by-state analysis comes out of the books. The taxability and nexus determination comes off the business tax side, state by state. When those two halves live in two different firms, the exposure stays unquantified, which is how a company ends up disclosing that no estimate can be made when a number was available the whole time.
Unasserted Sales Tax Exposure
ASC 450-20-50-6 is the paragraph almost nobody applies to a private company. Disclosure of a loss contingency involving an unasserted claim or assessment isn’t required where there has been no manifestation by a potential claimant of an awareness of a possible claim, unless both of two conditions are met. It has to be considered probable that a claim will be asserted, and there has to be a reasonable possibility that the outcome will be unfavorable. ASC 450-20-55-1 through 55-17 carry the implementation guidance.
Map that onto an unregistered seller. No state has sent a notice, so the claim is unasserted. Is assertion probable? States hold the revenue data, run marketplace and 1099-K reporting, operate active nexus questionnaire programs, and the company has been above threshold there for several years. Is an unfavorable outcome reasonably possible? If the product is taxable in that state and nothing was collected, yes. Both conditions met means disclosure is required even though nobody has asserted anything. And if a liability was probably incurred and you can estimate it, ASC 450-20-25-2 requires the accrual, not just the footnote.
Sizing the Exposure, and Why a VDA Changes It
South Dakota v. Wayfair overruled the physical presence rule in 2018. The statute the Court upheld reached sellers delivering more than $100,000 of goods or services into South Dakota annually or completing 200 or more separate transactions. GAO reported that as of September 2022, 22 states and the District of Columbia had adopted that same threshold pair, with the rest differing on the values and on how they’re computed.
Taxability is a separate question from nexus. New York treats prewritten computer software as taxable whether it’s delivered on media, by electronic transmission, or by remote access, which captures most SaaS. Texas taxes SaaS as a data processing service with 20% of the charge exempt. Other states don’t tax it at all.
So the estimate is revenue by state, times the taxable share, times the combined rate, plus interest, plus penalty, state by state and period by period. California shows what the add-ons do. A 10% penalty applies for failing to file or pay on time, interest runs from the date the tax became due, and a 50% penalty applies where someone knowingly fails to obtain a permit before the first return is due in order to evade payment.
A voluntary disclosure agreement is a measurement action, not only a tax strategy. Under the Multistate Tax Commission’s Multistate Voluntary Disclosure Program, a taxpayer negotiates a uniform agreement with multiple states through the National Nexus Program, files returns, pays past-due tax plus interest for the lookback period, and registers. The state waives penalties and waives tax for periods before the lookback, and each state sets its own lookback. A capped lookback with penalties removed collapses the range, which turns an open-ended exposure that supported only an estimate-cannot-be-made disclosure into a bounded liability you can accrue under ASC 450-20-25-2.
Worker Classification, Indemnities, and the Diligence Endgame
An employment tax exposure from treating a worker as a contractor is an ASC 450 contingency too, and the GAAP conclusion turns on a tax answer. Classification rests on the common law test of control. Section 530 of the Revenue Act of 1978 can relieve federal employment tax liability where the employer satisfies reporting consistency, substantive consistency, and a reasonable basis for the treatment, and the IRS is explicit that Section 530 relief doesn’t determine that the worker is in fact a contractor. It relieves the liability. Availability of that relief is a direct input into whether a loss is probable at all. State unemployment and state wage-law exposure runs on a separate and often larger track.
An indemnity claim follows the ordinary ASC 450-20 analysis once asserted. An indemnity structured as a guarantee may fall inside ASC 460, which requires disclosure even when performance is remote, so answer that scope question deliberately rather than by default.
An exposure that was neither accrued nor disclosed doesn’t go away when an investor’s advisors find it. It comes back as an escrow, an indemnity holdback against the tax representations, or a reduction in price. A company that accrued the exposure and disclosed the range has already priced it, and financial due diligence becomes a conversation about the remediation plan, not about what else the books don’t show.
Common Pitfalls
These surface in the same place, a close review that asks what changed in the legal and tax files this month rather than only what cleared the bank. A disciplined month-end close is what keeps the register current.
- Waiting for resolution. The trigger is a probable, estimable liability at the balance sheet date, not a judgment or a signed settlement. ASC 450-20 contemplates accrual while the matter is still open.
- Accruing the midpoint. That’s IAS 37 paragraph 39. US GAAP accrues the minimum under ASC 450-20-30-1 when no amount in the range is a better estimate.
- Netting insurance against the liability. ASC 720-20-45-1 prohibits it absent the ASC 210-20-45-1 right of setoff, which an insurer and a plaintiff can’t satisfy.
- Disclosing nothing because no number exists. ASC 450-20-50-4 explicitly accepts a statement that an estimate cannot be made.
- Treating uncollected sales tax as a filing problem. It’s a GAAP liability under ASC 450-20 the moment it’s probable and estimable, whether or not a return is ever filed.
- Accruing a gain contingency. ASC 450-30-25-1 bars it until realized, including the recovery you’re confident of winning.
- Calling the accrual a reserve. ASC 450-20-50-1 prohibits that label.
- Running a non-income tax exposure through ASC 740. ASC 740-10-15-3 puts it outside that scope.
Most generalist firms miss the ones that don’t involve a lawyer, items five and eight especially. Indinero’s CPA team catches these during monthly close review, while the conclusion is still cheap to change.
The Audit-Ready Standard
The audit-ready position on contingencies is a standing register, not an answer assembled during fieldwork. PCAOB AS 2505, Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments, puts the obligation on management rather than on the auditor.
Management is responsible for adopting policies and procedures to identify, evaluate, and account for litigation, claims, and assessments as a basis for preparing GAAP financial statements. The auditor inquires about those policies, obtains management’s evaluation of matters existing at the balance sheet date, obtains assurance that everything requiring disclosure has been disclosed, and examines correspondence and invoices from lawyers. AU-C 501 is the AICPA analogue for private company audits. Counsel supplies the legal assessment. Management makes the accounting conclusion and owns the documentation.
Two consequences worth planning around:
- Legal invoices are an audit procedure. A matter nobody mentioned still surfaces through counsel’s billing.
- The audit letter asks about unasserted claims management already considers probable of assertion. That identification is a company deliverable produced before the audit, not during it.
So the register carries, for every matter, the likelihood conclusion, the basis for it, the estimate or the documented reason none can be made, and the accrual or disclosure decision with the paragraph relied on. Refresh it at each close and audit prep stops being a reconstruction exercise.
Audit-ready, not audit-painful.
How Indinero Approaches Loss Contingencies
Indinero’s accounting team is CPA-led, and every monthly close gets a GAAP-discipline review before it ships. For contingencies, that means the register is maintained inside outsourced accounting services month by month, rather than assembled the week an auditor or an investor asks for it.
The structural piece matters more here than on most technical topics. Sizing an uncollected sales tax exposure takes a revenue-by-state analysis from the books and a taxability and nexus determination from the tax side. Bookkeeping, GAAP close, business tax, and fractional CFO advisory sit inside one monthly engagement at indinero, so both halves of that answer come from the same team. That’s the difference between accruing a measurable liability and disclosing that no estimate is possible. For software companies, our SaaS accounting services work sits in the same engagement, which is where most of these exposures start.
The track record behind it: continuous operations since 2009, 500+ regular customers, 100+ years combined team experience, SOC 2 compliant (2026). Pricing starts at $750/mo. Month-to-month engagements available.
An exposure you’ve already accrued and disclosed is a priced item. One nobody has looked at is a diligence finding waiting to happen. If you’re carrying something that has never been quantified, that’s worth a conversation with a finance partner who can do both halves of the work. Start with a free consultation.
Frequently asked questions
The questions Controllers and VPs of Finance ask most often about contingent liability accounting, answered below.
Does uncollected sales tax in a nexus state have to be accrued?
Yes, uncollected sales tax has to be accrued once the liability is probable and reasonably estimable, under ASC 450-20 rather than ASC 740. Sales and use tax sits outside the ASC 740 income tax scope, so the two-condition ASC 450 test governs, and economic nexus means the liability exists whether or not a state has made contact. Sizing it takes a revenue-by-state analysis from the books and a taxability determination from the tax side, which is why indinero keeps both halves inside one monthly engagement.
Can we keep a legal reserve out of the footnotes so the plaintiff does not see it?
No, a required ASC 450 disclosure can’t be omitted to avoid tipping off a plaintiff, but GAAP doesn’t require a claim-by-claim dollar figure. Aggregating similar matters by class, rather than disclosing matter-level dollar detail, is accepted practice that SEC staff hasn’t objected to, and ASC 450 carries no tabular rollforward requirement. Where the disclosure itself would be prejudicial, the available accommodation is narrow, and ASC 450-20-50-1 separately prohibits calling the accrual a reserve.
Who decides whether a loss is probable, us or our attorney?
Management makes the probability conclusion and owns it, counsel supplies the facts and legal assessment, and the auditor tests the judgment. PCAOB AS 2505 puts the obligation on management to adopt policies to identify, evaluate, and account for litigation, claims, and assessments, with AU-C 501 as the private company analogue. An attorney who won’t give you a number isn’t grounds for silence, it’s grounds for disclosing that an estimate can’t be made.
Does an accrued contingency reduce our taxable income?
Generally no, a book accrual under ASC 450 isn’t deductible until economic performance occurs, so it creates a deferred tax asset instead. For torts, breach of contract, and violation of law, the all-events test generally pushes economic performance to the date of payment, so the book-to-tax difference is timing rather than permanent. Build the deferred item into the tax provision when the accrual is booked, not at the next return.
What happens to an accrued exposure in Series B diligence?
An accrued and disclosed exposure shows up in Series B diligence as a priced, negotiated item rather than a discovery. An exposure that was neither accrued nor disclosed and then surfaces in diligence usually comes back as an escrow, an indemnity holdback against the tax representations, or a reduction in price or valuation. A register refreshed at each monthly close, carrying the likelihood conclusion, its basis, and the paragraph relied on, is what keeps the exposure a priced item instead of a finding.
