Question

2. What are the three ways of dealing with (accounting for) contingent liabilities

Answer 1

There are 3 types of contingent liabilities & each are accounted differently

1.. Probable contingent liabilities --- are those that are certainly probable to occur in future--for example that it is certain to incur a specified amount of tax liability in the future.

Accounting :

If a contingent liability is probable and the also amount could be reasonably estimated, the liability is accounted in the financial statements by reducing net income and increasing liabilities. To illustrate, warranties on some faulty product estimated at $ 25000 income is reduced by a warranty expense to that amount, and the balance sheet liability account accrued warranties is increased .

2. Reasonably possible Contingent liabilities-----

those that are not as probable ,but not remote either.Such as the verdict in a law-suit, the outcome of which may go either side--but the amount ,if held against is not possible to be estimated.

Accounting :

As the amount cannot be estimated, these are disclosed as notes to the financial statements--expressing that the matter is pending litigation.

3..Remote Contingent liabilities---

Are those whose chances of happening in the future are totally remote---such as warranty claims on a recalled product-- absolutely NIL.

Accounting :

These are neither disclosed in notes to the financial statements nor accounted within the financial statements.