What Are Contingent Liabilities? Definition, Explanation, Examples

If any order is passed to stop the extraction, then the companies will incur huge losses. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Finally, during 2019, the company incurred $35,000 of warranty expenditures related to these printers. The matching convention requires the recording of the expense in the period of the sale, not when the repair is made.

Since a contingent liability can potentially reduce a company’s assets and negatively impact a company’s future net profitability and cash flow, knowledge of a contingent liability can influence the decision of an investor. At the end of the year, the accounts are adjusted for the actual warranty expense incurred. In this scenario, the contingent liability is not recorded or disclosed if the probability of its occurrence is remote. Here, ‘remote’ means the contingencies aren’t likely to occur and aren’t reasonably possible. To further simplify, the loss due to future events is not likely to happen but not necessarily be considered as unlikely. It could be a situation where the liability is probable, but the amount couldn’t be estimated.

Remote

It’s impossible to know whether the company should report a contingent liability of $250,000 based solely on this information. Here, the company should rely on precedent and legal counsel to ascertain the likelihood of damages. Furthermore, in many cases, the actual payee of the liability is not known until the future event occurs. Generally, the amount of these liabilities must be estimated; the actual amount cannot be determined until the event that confirms the liability occurs. If the contingent loss is deemed remote—specifically, with less than a 50% probability of occurrence under IFRS—the formal disclosure and recognition on the balance sheet is not necessary. The factor of uncertainty, where the outcome is out of the company’s control for the most part, is one of the core attributes of contingent liabilities.

• If the value can be estimated, the liability must have more than a 50% chance of being realized.
• One major difference between the two is that the latter is an amount you already owe someone, whereas the former is contingent upon the event occurring.
• It does not know the exact number of vacuums that will be returned under the warranty, so the amount must be estimated.
• The goods were delivered by ABC on time, but due to heavy rain during transit, few goods were damaged.
• However, unless the possibility of an outflow of economic resources is remote, a contingent liability is disclosed in the notes.
• So the mobile manufacturer will record a contingent liability in the P&L statement and the balance sheet, an amount at which the 2,000 mobile phones were made.

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IAS 37 Provisions, Contingent Liabilities and Contingent Assets

The accrual account enables the company to record expenses without requiring an immediate cash payment. If the case is unsuccessful, $5 million in cash is credited (reduced), and the accruing account is debited. The principle of materiality states that all items with some monetary value must be accounted into the books of accounts. Items can be considered to have a monetary value if their inclusion or exclusion has an impact on the business.

These liabilities are categorized as being likely to occur and estimable, likely to occur but not estimable, or not likely to occur. Generally accepted accounting principles (GAAP) require contingent liabilities that can be estimated and are more likely to occur to be recorded in a company’s financial statements. If a loss from a contingent liability is reasonably possible but not probable, it should be recorded as a disclosure in the footnotes to the financial statements. The company should record the nature of the contingent liability and give an estimate or range of estimates for the potential loss.