Contingent liability definition
/What is a Contingent Liability?
A contingent liability is a potential obligation that may arise from an event that has not yet occurred. It 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 noted below.
Record a Contingent Liability
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.
Disclose a Contingent Liability
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.
Do Not Disclose a Contingent Liability
Do not record or disclose a contingent liability if the probability of its occurrence is remote.
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Examples of Contingent Liabilities
Examples of contingent liabilities are the outcome of a lawsuit, a government investigation, and the threat of expropriation. A warranty can also be considered a contingent liability.
For example, a customer files a lawsuit against a business, claiming that its product broke, causing $500,000 of damage. The organization’s attorney believes that the customer will win in court, and believes that the firm will have to pay the full $500,000. Because this outcome is both probable and easy to estimate, the company’s controller records an expense of $500,000. If the attorney had instead felt that the loss was only possible, rather than probable, then there would be no need to record the expense; instead, the controller would merely disclose the issue in the footnotes accompanying the firm’s financial statements.