A contingent liability is a potential financial obligation that may occur in the future, based on the outcome of a specific event in the present. The occurrence is contingent or dependent on an event that might or might not happen. These liabilities are often not reported in a company’s financial statements, since they are uncertain, but they can significantly impact a company’s financial health. Common examples include litigation, warranty repairs or replacements, environmental cleanups, and possible debt obligations.
1. How does a company account for a contingent liability?
A company records a contingent liability in its books only when the liability is probable and the amount of liability can be reasonably estimated. If it’s likely but the cost is hard to estimate, the liability is disclosed in the notes of financial statements.
2. What are the types of contingent liabilities?
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There are three types: probable, possible, and remote. Probable liabilities are likely to occur and can be estimated, possible liabilities have less certainty but could occur, and remote liabilities are unlikely to happen.
3. What is an example of a contingent liability?
An example of a contingent liability could be a lawsuit. A company may get sued and possibly have to pay damages, but until the jury decides, the amount of this liability is unknown.
4. When is a contingent liability recorded?
A contingent liability is recorded in two conditions: when it’s probable the liability has been incurred, and when the amount of the liability can be reasonably estimated.
5. Are all contingent liabilities recorded in financial statements?
No, only probable and estimable contingent liabilities are recorded in the financial statements. Possible and remote liabilities are usually disclosed in the notes.