This is a senerio Casey jones owns a successful roofing company and is preparing for retirement. His company is incorporated so it is cosidered to be its own entity and bears its own liability. Casey is in final negotiations for the sale of the corporation and has his senior accountant has prepared financial statements. The accountant has included a separate pge that details infortmation pertaining to the mortgage on the building ,leases on the lge boom equipment and vehicles operating loan and any legal obligations that the company may be currently engaged in. Casey Jones recently received a letter from his lawyer informing him that legal documents have just arrived pertaining to a roofing contract from 6 months prior that developed complications due to a installation error. The documents indicate a law suit is pending to cover damages to the business of approx.3,450,000 when the flat roof collapsed during a heavy rain fall which destroyed most of a antique motorcycle collection, Casey felt that he was able to win the law suit and that it was not necessary to pass the info to his senior accountant until the law suit was in its final stages. Which gap principal was violated. How was it violated and how to fix it. ( I say the gap principal violated was full disclosure principal)

Any potential liability must be disclosed. These are called contingent liabilities.

There are a number of ways this omission can be fixed in the accounts.

Creating a provision for litigation losses and charging the current years profit

The business should be carrying professional indenmity insurances. In that case a note might be appended to the accounts indicating the liability exists but will be offset by the insurance claim