Contingent Liability

What Is a Contingent Liability?

A contingent liability is a liability that might happen depending on the outcome of an uncertain future event. A contingent liability is recorded in the event that the contingency is possible and the amount of the liability can be sensibly estimated. The liability might be unveiled in a commentary on the financial statements except if the two conditions are not met.

Grasping Contingent Liabilities

Pending lawsuits and product guarantees are common contingent liability models on the grounds that their outcomes are uncertain. The accounting rules for reporting a contingent liability contrast depending on the estimated dollar amount of the liability and the probability of the event happening. The accounting rules guarantee that financial statement perusers receive adequate data.

An estimated liability is certain to happen — thus, an amount is constantly placed into the accounts even on the off chance that the exact amount isn't known at the hour of data entry.

Illustration of a Contingent Liability

Expect that a company is facing a claim from a rival firm for patent infringement. The company's legal department feels that the rival firm has a strong case, and the business estimates a $2 million loss in the event that the firm loses the case. Since the liability is both probable and simple to estimate, the firm posts an accounting entry on the balance sheet to debit (increase) legal expenses for $2 million and to credit (increase) accrued expense for $2 million.

The accrual account permits the firm to post an expense without the requirement for an immediate cash payment immediately. In the event that the claim brings about a loss, a debit is applied to the accrued account (deduction) and cash is credited (diminished) by $2 million.

Presently expect that a claim liability is conceivable however not probable and the dollar amount is estimated to be $2 million. Under these conditions, the company uncovers the contingent liability in the footnotes of the financial statements. Assuming the firm establishes that the probability of the liability happening is remote, the company doesn't have to unveil the possible liability.

Both GAAP (generally accepted accounting principles) and IFRS (international financial reporting standards) expect companies to record contingent liabilities as per the three accounting principles: full disclosure, materiality, and judiciousness.

A warranty is another common contingent liability in light of the fact that the number of products returned under a warranty is obscure. Expect, for instance, that a bicycle manufacturer offers a three-year warranty on bike seats, which cost $50 each. In the event that the firm produces 1,000 bike seats in a year and offers a warranty for every seat, the firm requirements to estimate the number of seats that might be returned under warranty every year.

On the off chance that, for instance, the company figures that 200 seats must be substituted under warranty for $50, the firm posts a debit (increase) to warranty expense for $10,000 and a credit (increase) to accrued warranty liability for $10,000. Toward the year's end, the accounts are adjusted for the real warranty expense incurred.

Features

• Contingent liabilities are recorded to guarantee that the financial statements are accurate and meet GAAP or IFRS requirements.
• A contingent liability is a potential liability that might happen from here on out, like pending lawsuits or regarding product guarantees.
• On the off chance that the liability is probably going to happen and the amount can be sensibly estimated, the liability ought to be recorded in the accounting records of a firm.

FAQ

What Are the 3 Types of Contingent Liabilities?

GAAP perceives three categories of contingent liabilities — probable, conceivable, and remote. Probable contingent liabilities can be sensibly estimated (and must be reflected inside financial statements). Conceivable contingent liabilities are as liable to happen as not (and require just be uncovered in the financial statement footnotes) and remote contingent liabilities are very improbable to happen (and needn't bother with to be remembered for financial statements by any means).

What Is a Contingent Liability?

A contingent liability is a liability that might happen depending on the outcome of an uncertain future event. A contingent liability must be recorded on the off chance that the contingency is possible and the amount of the liability can be sensibly estimated. Both GAAP and IFRS expect companies to record contingent liabilities.

What Are Examples of Contingent Liability?

Pending lawsuits and guarantees are common contingent liabilities. Pending lawsuits are viewed as contingent on the grounds that the outcome is obscure. A warranty is viewed as contingent on the grounds that the number of products that will be returned under a warranty is obscure.