Question

This week is all about current liabilities. One category of liabilities a company might be involved in are "contingencies". Consider the following questions related to contingent liabilities:

a). What are contingent liabilities?

b). Describe the criteria for reporting a contingent liability.

c). Find a Real World example of a contingent liability reported on a company's annual financial statements (use an example based on research outside of the textbook). Describe the contingent liability and how it is reported.

Answer 1

a) Contingent liability is a potential liability that may occur, depending on the outcome of an uncertain future event. A contingent liability is recorded in the accounting records if the contingency is likely and the amount of the liability can be reasonably estimated.

b)A contingent liability is recorded in the accounting records if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements or not reported at all if both conditions are not met. If the contingent loss is remote, meaning it has a less than 50 percent chance of occurring, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.

C)Suppose a lawsuit is filed against a company, and the plaintiff claims damages up to $250,000. 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. If a court is likely to rule in favor of the plaintiff, whether because there is strong evidence of wrongdoing or some other factor, the company should report a contingent liability equal to probable damages. This is true even if the company has liability insurance.If the lawsuit is frivolous, there may be no need for disclosure. Any case with an ambiguous chance of success should be noted in the financial statements but need not be listed as a liability on the balance sheet.