Question

What are two examples of an estimated liability? What are two examples of contingent liabilities? Why are companies required to record liabilities that are estimated instead of allowing them to wait until the exact amount is known?

Answer 1

Definition of an Estimated Liability

An estimated liability is a liability that is absolutely owed because the services or goods have been received. However, the vendors' invoices have not yet been received and the exact amount is not yet known.

Examples of Estimated Liabilities

Liabilities that are not contingent liabilities but are estimated liabilities include the following:

· The electricity and natural gas consumed but the bill has not been received

· An emergency repair that occurred but the bill has not been received

· Real estate taxes that have occurred but the tax bill has not been received

· Worker compensation insurance premiums which have occurred but the bill has not been received

These liabilities must be recorded by using estimated amounts.

Definition of a Contingent Liability

· A contingent liability is a potential liability (and a potential loss or potential expense). For a contingent liability to become an actual liability a future event must occur.

· Examples of Contingent Liabilities

· Assume someone files a lawsuit against Jay Corp. Jay Corp now has a contingent liability. The lawsuit will become an actual liability only if Jay Corp is unsuccessful in defending itself. (Many lawsuits are nuisance suits that will not be victorious in court.)

· Another contingent liability is the warranty that automakers provide on new bikes. Since it is probable (not merely possible) that some vehicles will require work during the warranty period and the automakers can estimate that amount, the estimated amount of the warranty cost will be reported as a liability on the automakers' balance sheets at the time that the cars are sold. The other part of the journal entry is to debit Warranty Expense and report it on the income statement.

Reason why estimated liabilities are recorded inspite not knowing exact :

The company is required to estimate the amount since the estimated amount is far better than implying that no liability is owed and that no expense was incurred. Many of the accrual adjusting entries require estimated amounts.