Question

Contingent liabilities are a little quirky as far as accounting goes, as they represent something that may or may not be a liability. Brainstorm and describe your own example of a contingent liability. Post your scenario and state how you would handle the accounting (record/disclose/do not disclose).

Answer 1

contingent liability is defined as a liability which may arise depending on the outcome of a specific event. It is a possible obligation which may or may not arise depending on how a future event unfolds. A contingent liability is recorded when it can be estimated, else it should be disclosed.

Description: A contingent liability is a liability or a potential loss that may occur in the future depending on the outcome of a specific event. Potential lawsuits, product warranties, and pending investigation are some examples of contingent liability.

If the amount can be estimated, the company sets aside that amount separately to be paid out when the liability arises. Contingent liability as a term does not apply only to companies, but to individuals as well.

For example, if you took an educational loan of Rs 10,000,000 from your bank to fund your child’s higher studies. That amount could well become a contingent liability if your child fails to make monthly payments after getting a job. You might have to pay the amount because you have taken the loan from your bank.

Let’s understand contingent liability from a company’s point of view. Your company might be in the middle of a lawsuit and your lawyer thinks that the other party has a strong case which could potentially lead to damages worth Rs 10 crore.

In that case, the company would book that amount as contingent liability on its balance sheet. On the other hand, if the lawyer or the legal department thinks that the other party does not have a very strong case in hand. They would advise the firm not to make any provision of a contingent liability.

When the probability of a contingent liability is low then is no journal or even a disclosure is required in the books of accounts