Contingency Account

by Colleen
(Ottawa, Ontario, Canada)

What entries are required at year end to set up a contingency fund?



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Hi Colleen,


I'm assuming that you want to set up a contingent liability because there is a probability a liability will be incurred AND the amount of the liability can be reasonably estimated.

Normally this type of entry relates to a future event that may occur such as litigation, guarantees, warranties, outstanding coupons.

As a general rule, it would entail disclosure AND a journal entry debiting an expense account (on the income statement) and crediting a contingent liability account (on the balance sheet).

If the two conditions above are NOT met, you do NOT make a journal entry ... you only make a disclosure if the future event is possible but not probable. I don't believe GAAP permits reserves for general contingencies.

If the future event is unlikely, no disclosure is required.

The accountant preparing the financial statements should really be the person booking this type of advanced accounting entry.

I do not recommend bookkeepers making this type of entry unless they are well versed in GAAP and have worked in an accountant's office (in a supervised environment) for a number of years where they had exposure to the need for this type of entry.

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Nov 13, 2010
Replacement Reserves
by: Bookkeeping Essentials

Colleen wrote to me and explained she was looking for information on replacement reserves not contingent liabilities.

My understanding of the purpose of a reserve for future major repairs and replacements is to ensure adequate funds are available to meet future costs. The reserve itself is a separate bank or investment account. It requires amounts to be physically transferred from the operating account to the reserve account.

This means the entry to setup the reserve would simply be DR Replacement Reserve CR Cash in Bank where the "Cash in Bank" would be your operating account ... and "Replacement Reserve" is an asset account.

I found two articles that may assist anyone interested in how to operate the reserve fund.

One is CMHC's Replacement Reserve Guide found at http://www.chfcanada.coop/eng/pdf/ResourceDocs/replac_reserve_guideEN.pdf.

The second is an article by the US CPA firm Porter & Associates on how to audit replacement reserves found at http://www.porterandcompany.com/Articles/AuditingReserves.pdf.

Canada's auditing procedures would probably be similar, so it gives you good tips on how to manage the reserve account.

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