On being informed on the possible suit against the hospital for negligence, the hospital will be forced to anticipate legal costs that may arise from the impending lawsuit. The hospital accounting department will be forced to rely on the FASB Statement No.5 dubbed Accounting for Contingencies to report this incident. It is prudent to note that the clients have not filed any claim yet against the hospital. Therefore these are anticipatory costs which the hospital management must be aware of.
In light of the FASB statement Number 5, loss of contingency can be pronounced and recognized in either two scenarios: “an asset has been impaired, or a liability has been incurred” (Granof & Khumawala, 2013) . In this case, probable translates to the high likelihood of something having occurred. For the suit to be deemed to be a liability, the hospital must establish that there will be an outflow of resources to meet this obligation. It is prudent to note that legal suits are costly as they may attract fines and possible demands compensation from the plaintiff, the client, who is suing the facility for negligence.
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The financial statements at the hospital will be affected by a possible increment in the legal payouts. By relying on jurisprudence from previous litigation on hospital negligence, the hospital can estimate the compensation and other associated legal fees which culminate in an accrual in accounting terms. The accrual will be treated as part of incurred expenses. Using the accrual method, the hospital accounting department will adjust records to reflect these expenses that may be incurred but are not yet recognized in the books. Additionally, through the double-entry bookkeeping, any offset to an accrued expense is deemed to be an accrued liability account which ends up appearing on the balance sheet. In the end, the accrual entry that is the legal fees and compensation will have an impact on the income statement and balance sheet.
References
Granof, M. H., & Khumawala, S. B. (2013). Government and not-for-profit accounting: Concepts and practices (6th ed.). Hooboken, NJ: Wiley.
