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Commitments and Contingencies | Full Disclosures | Examples - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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by clicking the bell icon friends today we
are going to learn a concept that is on
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commitments and contingencies we're
going to see some of the disclosures and
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the examples of the same at the very
force end you can see that is leading up
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to the quarterly earnings announcement
on Wednesday a bit of bit bad news
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surfaced off for Facebook it's virtual
reality factory oculus which had been
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embroiled in the lawsuit filed by
Maryland based gaming company lost the
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suit and they were ordered to pay 500
million so know what the very first and
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the foremost thing from what exactly is
commitments and contingency see a
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commitment is basically an obligation of
a company to external entities that
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often arises in connection with the
legal and contracts executed by the
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company see contingencies however are
different from commitments they have a
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really great amount of difference it is
implied that you know obligations that
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is expected to take place depending upon
the outcome of the future event here
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once you can say that the contingencies
are those obligations that may or may
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not you know become liabilities to the
company because of the uncertainty of
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the future event but we as we can see
from the above from the snapshot that we
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just saw
you know Facebook's virtual reality
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division of oculus has been in a lawsuit
due to the allegation of violating the
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nondisclosure agreement and they
cooperated infringement and more so
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Facebook in its SEC filing you know has
included the lawsuit under the
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contingencies and liabilities section
contingencies liability section so in
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this to tutorial the scars will discuss
the nuts and the bolts of commitments
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and contingencies first first let's
start with what exactly is commitments
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let's understand the first of the four
most things in case of commitment a
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commitment is basically an obligation of
a company to external entities that
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often arises in connection with the
legal contracts it
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arises in case of the legal contracts
and executed by the company so in other
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words commitments are the potential they
can be said as potential claims that are
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been against a company with a respect to
its future performance under legal
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contract so they're there for a one can
say that commitments are those
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agreements therefore we can say that
commitments are those agreement that are
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expected to take place in the future
however if the company hasn't made any
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payment and therefore one can say that
the commencement our commitments are
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those that are expected to take place in
future nevertheless the company has to
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make disclosure of such commitments
along with the nature and amount of any
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unusual terms and condition in the 10k
annual reports or SEC filing so this
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agreements basically or contracts may
include like you know first short-term
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and long-term contractual obligations
with the supplier for the future
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purchase so short and long term you can
say purchases short and long-term
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contractual obligation second is known
as the capex that is the capital
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expenditures commitment contracted but
not yet incurred anything as feared the
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third is non cancel able operating leases
is the next then we have the fourth is
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lease or leasing of the property land
facilities or equipment land facility
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and equipments the fifth is unused
litters and use letter of credit which
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is known as unused LOC to reduce their
so let's understand the commitment
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through an example suppose let's say
let's say there is a company which plans
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to purchase a raw material under a
predetermined contract but as for the
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agreement the company will make payments
for this raw materials only after these
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raw materials have been received
although the company will require cash
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for this raw material in the future the
event of the transaction hasn't yet
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occurred but at the time of the
preparing the balance sheet hence no
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amounts recording either in the income
statement or the balance sheet however
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the company is expected to make
disclosure for such transaction as they
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are supposed to occur in the future and
will impact its cash position therefore
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the company provides an extensive
explanation regarding this commitments
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in the notes to the financial statement
now the next thing that we are going to
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study is that you know what do
commitment tell you like you know we'll
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take
over here the example of a Casteel okay
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when win such commitments are described in the notes to the financial statement
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the investors and the creditors will go to
low that you know will get to know that
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the company has taken a step and this
step is likely to lead to a liability so
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basically you can say that you know the
information concerning the future
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commitment remains critical for the
analyst lenders shareholders investors
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because that provides a complete picture
of the company's current and future
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liability now let's take a real-life
example of a form and find out that what
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are its current and future commitments
and how they are presented in the
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financial statement like for a for an
example over here we are going to take
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an example of AK steel which is
basically in NY AC which known in
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inverse it is known AK has entered
into V this contract that obligates the
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company to make legally enforceable
payments so this is women's include like
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borrowing money
it's like borrowing money leasing and
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equipment and purchasing goods and
services iike steel has given a detailed
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information regarding this commitments
which is as follow so as you can see
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over here there is a detail regarding
the contractual obligation there is a
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lease obligation and purchase obligation
and payments so as you have seen in the
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above snapshot of a AK Steel you know has given an extensive explanation regarding
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its future commitments basically and our
obligation in the notes to financial
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statement the most important point to
observe you is that you know despite
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being the liabilities commitment are
shown on the balance sheet it is because
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the commitment needs a special treatment
and therefore they are disclosing the
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footnotes of the financial statements
likewise AK steel has given a complete
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information regarding its operating
leases operating leases are the
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commitments to pay the future among
however it is not recorded as
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liabilities insert the company recorded
records in the financial statement
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basically or in the 10k annual report
okay in basically in the footnote so
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this key disclosure includes items like
the length of the lease expected yearly
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payments coupled with the minimum lease
payments over the entire term of the
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lease so the graph which I am going to
show you that will illustrate a caste is
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operating lease payments for the lease
period as you can see the operating
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lease over here there are details that
are given for 2017
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rental expenses and the minimum total
minimum lease treatment which is sixty
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4.9 which is the sum total
of a nut of all another example of the
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commitment could be a decision of the
capital investment that our company has
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contracted with a third party but it
hasn't been yet incurred like for
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example AK steel has a commitment for
the future capital investment of
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42.5 dollar that it
plans to incur in 2017 all the way
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AK Steel has entered into the agreement
it is not really guarded the amount in
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the balance sheet in 2016
because it hasn't yet incurred in the
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investment so still it has given a note
in the financial statement that I'll
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show you in the snapshot see it's
written over here in the snapshot of the
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commitment V purchase of a substantial
portion of the principal rawmaterial
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require for our steel manufacturing the
commitments for the future capital
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investments as in total to $42.5 dollar and all which we
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expect to incur in 2017 now let's
discuss what do commitments tell you
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we'll take over here the example of
Facebook say Facebook has as a primary
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two type of commitment the first we'll
discuss over here the first one is
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leases so basically Facebook has entered
into various non cancel able operating
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leases and see NCOL that is non canceled
operating lease agreements for the
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offices data centers and facilities so
operating these expenses for 2017 is
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close enough to 277 million dollar let
me show you that in article over here
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there's a details of operating leases
2017 data 1819 as you can see the 2017
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data is 277 million dollar and the
second over here that we are going to
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discuss is the details regarding the
first was ncol and the other is other
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contractual contractual commitment so
that is the case see Facebook has
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already entered into the non cancel
contract a commitment of $1.24
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billion dollar $1.24
billion dollars related to the network
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infrastructure and data center operation
so this commitments are due within five
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years
so as an analyst it is very important to
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make note of this commitment as they
affect the
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- of the company so what are
contingencies that is the next thing si
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contingencies are basically you can say
they are different from the commitments
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it is implied obligation you know what
that is expected to take place depending
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on the outcome depending on the outcome
of the of the future event so hence one
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can say that the contingencies are those
obligation that may or may not become
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liabilities to the company because of
the uncertainty of the future event okay
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so that is the case let's understand the
contingencies by a by an example
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assuming that a company's suit for a
formal employees a former employer for
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around let's say $1,000 okay because the
employer feels that he has been
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terminated wrongly so he so does it mean
that the company has a liability of
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$100,000 well it depends on the outcome
of this event so if the company
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justifies that the termination of the
employee may not be elaborate with the
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company however the company fails to
justify the termination of the employee
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it will have to incur $1,0000
in the future because
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of the employee has won the lawsuits
there is a thing all airfares be okay
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has recognized a number of example for
the loss of contingencies that are
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evaluated and reported in the same
manner this can loss contingencies are
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like you know the first one is like the
risk of the loss then we have the threat
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of the express expropriation of the
assets the third is basically you can
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see the actual all the possible
assessments the fourth is spending or
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the threatened a litigate litigation and
the fifth is obligation related to the
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product warranties and product defects
now let's learn about the next that is
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the reporting of contingencies in this
particular scenario there is a basic
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three critical treatment that have to be
taken care of while reporting
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contingencies and they are like you know
the first one is a loss contingency and
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is not recorded in the balance sheet if
it is not realize due to the in
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probability it means that it is if the
likely losses are not more than but I
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mean it is less than 50% or the
amount is not realizable measured they
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are not recorded in the balance sheet
meanwhile the gain contingencies are
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usually reported in the income
treatment upon realization these second
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over here is that if there is a probable
contingencies can be defined as more
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than 50% due to the prior obligation the
third is it if a probable loss can be
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determined based on the historical the
information then it is considered as a
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reliable measure now let's see what are
the loss contingencies see in case of
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the loss contingencies we can understand
with the help of an example
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the loss contingencies assuming that a
company incurs a contingency at the end
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of the year one at that time the company
believes that there is a loss of let's
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say close enough to a $300000
and is probable but a loss of
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$3,90,000 okay
and is is reasonably possible however
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nothing has been settled at the end of
the year - so on the time of preparing
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it at the on the time of preparing of
the balance sheet for the you - the
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company believes that the loss is close
enough to $347000
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and is probable but a loss of
$4,30,000 is reasonably this is
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reasonably possible finally at the end
of the year three at the end of the year
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three what happens the company pays
close enough to in the neighborhood of
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$2,70,000 to the third
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party to settle the problem
therefore the company recognizes again
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of how much it is basically this is not
27 - $2,70,000 so
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the final amount that we are going to
receive is 70,000 that
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is a different so now let us find out
how this gain has been calculated cv
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know that a loss of 3,00,000
has been identified right by the company
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at the end of the year 1 now I have
taken let's say 3,00,000
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$300000 because it is
probable amount more than that is 50%
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however the company expects to recognize
an additional probable loss of
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40000 at the end of the year - in
this particular scenario that is it is a
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probable loss that is reported at the
end of the two is now basically
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close enough to 3,40,000 that is +300000
+$40,000 but at the end of the
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third year the company pays only let's
say $2,70,000 then in that scenario
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to the third body to settle the problem
then it recognizes again over here that
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has 3,40,000 this should be 3,40,000
less 2,70,000 just right over here
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that is basically 3,40,000 and 2,70,000 get that gives you
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final amount as 70,000 so this is
how the answer 70,000 year was been
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found now let me show you an example of
facebook contingencies example see among
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the other contingencies listed in
Facebook's SEC filing the most important
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is related to the oculus VR Inc versus
you knows in ZeniMax Media Inc sued
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Facebook for trade secret
misappropriation copper copyright
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infringement break of contract to
obvious inferences with contracts as any
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max was seeking actual damages of up to
close enough to India neighborhood of
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2.0 billion dollars punitive damages up
to 4.0 billion so on Feb 1 2017
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when the verdict was announced book was
asked to pay five hundred million in
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aggregate let me show you the article so
as you can see over here - it is written
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in the article the plaintiff for seeking
actual damages of two billion punitive
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damages of 4 billion and equitable
relief including the injunction and
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there was a definite on the amount of
the damages was awarded by the jury was
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500 million in the aggregate
and we believe to have a multiple
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grounds to appeal this result and intend
to vigorously pursue the appeals so
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after discussing all the things we can
finally make a conclusions on
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commitments and contingencies is that
the first and the foremost thing you
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know you can say organization in the day
to day life enters into contracts in
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order to run their business in the best
possible manner does this contracts you
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can say are considered as a very future
obligation I know which do not necessary
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qualify as a liability but the
organization have to describe this
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contracts in the notes of Finance
statements for nothing but more than the
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accounting purpose so whereas the
conveniences are considered as potential
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liabilities that might occur due to the
past events have ever liked you to have
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the loss or actual loss both remains
uncertain so that's it for this
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particular topic if you have learned and
enjoyed watching this video please like
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thank you everyone
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