Contingent Liabilities

Contingent Liability-Meaning with Examples

ACCOUNTING

Contingent Liability- Sometimes you will see there is a probability of getting something in your life. You will be uncertain about that thing and when you are uncertain then that will be your contingent liability. And in this post, you will learn all faqs related to contingent Liability and that will help you to understand it deeply.

What is Contingent Liability?

Contingent Liability is a possible obligation arising from past events and may arise in the future depending on the occurrence or non-occurrence of one or more uncertain future events.

What is the meaning of Contingent Liability?

A contingent liability means a possible obligation arising from past events and may arise in the future depending on the occurrence or non-occurrence of one or more uncertain future events and it may also be a present obligation.

An enterprise should not recognize a contingent liability in the balance sheet, however, it is required to be disclosed in the notes to accounts, unless the possibility of an outflow of a resource embodying economic benefits is remote. These liabilities are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognized in financial statements of the period in which the change in probability occurs except in the extremely rare circumstances where no reliable estimate can be made.

How will you define Contingent Liability?

A contingent liability may be defined as a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise.

Or it can be defined as a present obligation that arises from past events but is not recognized because:

  1. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation
  2. Or a reliable estimate of the amount of the obligation cannot be made.

What are the types of Contingent Liability?

Contingent liabilities are of two types which are:

  1. Explicit Contingent Liabilities: These liabilities are specific types of obligations that are created by the government or obligations which are legal in nature that is established by the law.
    1. Such as Currency exchange rates,
    2. Government insurance schemes on pension funds,
    3. bank bonds or bank deposits,
    4. Student loans,
    5. and mortgage loans.
  2. Implicit Contingent Liabilities: These types of liabilities are legal obligations that are identified after the occurrence of an event. Government sets the amount for the liability in such cases. They are not recorded in the books as these events may occur or may not occur.
    1. Such as-Disaster relief funds for people affected by a natural disaster,
    2. Social security,
    3. and Failure of the central bank on paying its obligations like the balance of payment.

What are contingent Liability examples?

You can see many examples of Contingent Liabilities and some of them are given below-

  1. Doubtful debtors.
  2. Financial guarantee
  3. Liquidated damages
  4. Destruction by flood
  5. Income tax dispute
  6. Change in foreign exchange
  7. Change of Government policy
  8. The possibility of loss from a Lawsuit Against a Company for Patent Infringement.
  9. Any type of Lawsuits
  10. Estate settlements

What are the features of Contingent Liability?

These are the features of Contingent Liabilities-

  1. A possible obligation arising from past events may arise in the future depending on the occurrence or non-occurrence of one or more uncertain future events.
  2. It may also be a present obligation.
  3. Contingent Liabilities are not recognized in the Balance Sheet.
  4. It is required to be disclosed in the notes to accounts unless the possibility of an outflow of a resource embodying economic benefits is remote.
  5. This depends on the occurrence or non-occurrence of one or more uncertain future events.

How is contingent Liability different from contingent Assets?

NOContingent LiabilityContingent Assets
1A possible obligation arising from past events may arise in the future depending on the occurrence or non-occurrence of one or more uncertain future events.A possible asset arises from past events and their existence will be confirmed only after the occurrence or non-occurrence of one or more uncertain future events.
2A contingent asset may be defined as a possible obligationA contingent asset may be defined as a possible asset
3Losses are uncertainBenefits are uncertain

How should contingent Liability be recognized?

An enterprise should not recognize a contingent liability in the balance sheet, however, it is required to be disclosed in the notes to accounts, unless the possibility of an outflow of a resource embodying economic benefits is remote. These liabilities are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognized in financial statements of the period in which the change in probability occurs except in the extremely rare circumstances where no reliable estimate can be made.

How is contingent Liabilities treated?

Contingent liabilities are never recorded in the financial statements of a company. These obligations have not occurred yet but there is a possibility of them occurring in the future. So a contingent liability has no accounting treatment as such.

How do you identify contingent liabilities?

An entity recognizes a provision if it is probable that an outflow of cash or other economic resources will be required to settle the provision. If an outflow is not probable, the item is treated as contingent liabilities.

When should contingent liabilities be disclosed?

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.

What will be the Journal entry for Contingent Liability?

The contingent liabilities treatment after the occurrence of an uncertain event.

For example, the company ABC Ltd. has an outstanding lawsuit which is likely that it will be a loss with the amount that can be reasonably estimated to be 35,000.

In this case, the company ABC Ltd. needs to recognize the expense and contingent liability immediately by making the journal entry as below:

loss from lawsuit Dr 35000
To Lawsuit payable 35000

In this journal entry, the lawsuit payable account is a contingent liability, in which it is probable that a 35,000 loss will occur. This leads to the result of an increase in liability (credit) by 35,000 in the balance sheet.

On the other hand, loss from a lawsuit account is an expense that the company needs to recognize (debit) in the current accounting period as it is a result of the past event (i.e. lawsuit). If the contingent liability journal entry above is not recorded, ABC’s total liabilities and expenses will be understated by 35,000.

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