Auditing and Attestation - Certified Public Accountant (CPA) Practice Exam 2025 - Free CPA Practice Questions and Study Guide

An entity would accrue a loss contingency during the audit period when there is a reasonable likelihood that a liability will occur, and the amount can be reliably estimated. This situation is particularly applicable when a claim has been identified with a probable adverse outcome. By the time of the audit report issuance, if the entity has determined that the likelihood of the loss occurring is probable, this requires the recognition of a liability in the financial statements.

Accruing the loss contingency at this point is necessary to ensure that the financial statements present an accurate picture of the entity's liabilities and financial position. Recognizing a loss reflects a responsible accounting treatment that adheres to the principles of conservatism, thereby allowing for the anticipation of losses that are probable and can be estimated, without waiting for the situation to fully materialize.

In contrast, recognizing a liability based on unfavorable outcomes being possible but not probable would not meet the criteria for accrual. Therefore, accruing based on a mere possibility or after the fiscal year-end is insufficient to justify recognition in the current period. The determination of impairment is also a separate assessment from loss contingencies and does not trigger the same accrual requirement unless it is directly related to a liability that is both probable and estimable.