Question

1. What is a contingent liability? (preferably in your own words; if you copy and paste, indicate source and page/slide number)

2. Why should the auditor contact the legal counsel (lawyer) about contingent liabilities? (answer in your own words, not the explanation to C below)

Look at the explanation for wrong answer D below.

3. Define the word accrued in the context of a contingent liability.

4. Bonus for max points: What is another term accountants use that has the same meaning as accrued in this context?

5. In the context of contingent liabilities, what does probable mean? Also give an example.

6. In this context, what does reasonably estimated mean? Also give an example.

7. Under what circumstances should a company accrue a contingent liability? Use some of the terms you have described above to answer this question. Also give an example.

8. Under what circumstances should a company disclose, but not accrue, a contingent liability? Use some of the terms you have described below to answer this question. Also give an example.

9. When accountants use the term disclose, what does that mean?

10. If a contingent liability is accrued, then it must also be disclosed, but not necessarily vice versa. True or False? Explain.

Answer 1

1.  A contingent liability is:
(a) 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
(b) a present obligation that arises from past events but is not recognized because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.

2. An Auditor must contact legal counsel inorder to understand the Outcome of the event. Based on the Opinion provided by legal counsel, probability is ascertained to consider as a contingent liability or provision.

3. Contingent liabilities should be recorded in the accounts when it is probable that the future event will occur and the amount of the liability can be reasonably estimated. This means that a loss would be recorded (debit) and a liability established (credit) in advance of the settlement.