I recently heard a radio advertisement for a pool building company. I do not recall all of the details, but the crux of the promotion was as follows. Over the next 90 days, the company would enter all new pool clients into a contest. If Phoenix had a record-high temperature (above 118 degrees Fahrenheit) on the upcoming July 4th, then all new pool clients would receive $12,000 cash. My first thought – how should the company account for this potential cost?
Likely, the firm has insured this event with some third-party. Thus, their costs consist of the policy premium plus the cost of the coinsurance/deductible that the pool company will pay if the record-high temperature is reached. This contingent liability is where the issue arises. Every time a pool is sold, the firm’s potential liability increases but the likelihood of the firm incurring any obligation remains at an equally unlikely level. It is difficult to measure but considering that the average July 4th high temperature is 107 degrees and the highest temperature ever recorded in Phoenix was 122 degrees, the chance that a record-high temperature will occur on that day is quite small. Thus, the company will likely not report any related liability on the balance sheet.
