A contingent liability is a potential obligation that may arise from an event that has not yet occurred. A contingent liability is not recognized in a company’s financial statements. Instead, only disclose the existence of the contingent liability, unless the possibility of payment is remote. There are three possible scenarios for contingent liabilities, all of which involve different accounting transactions. They are:
Recordation. Record a contingent liability when it is probable that a loss will occur, and you can reasonably estimate the amount of the loss. If you can only estimate a range of possible amounts, then record that amount in the range that appears to be a better estimate than any other amount; if no amount is better, then record the lowest amount in the range. “Probable” means that the future event is likely to occur. You should also describe the liability in the footnotes that accompany the financial statements.
Disclosure. Disclose the existence of a contingent liability in the notes accompanying the financial statements if the liability is reasonably possible but not probable, or if the liability is probable, but you cannot estimate the amount. “Reasonably possible” means that the chance of the event occurring is more than remote but less than likely.
No treatment. Do not record or disclose a contingent liability if the probability of its occurrence is remote.
Examples of contingent liabilities are:
The outcome of a lawsuit
A government investigation
The threat of expropriation
A warranty can also be considered a contingent liability.