Question

Explain how to account for liabilities, including contingent liabilities. Provide and example of each.

Answer 1

Liabilities are shown on the right side of the balance sheet like accounts payable, loans etc. And liabilities are having credit balance.

Liabilities are of two types-

1. Short term liabilities

2. Long term liabilities

Short time liabilities are those liabilities which are to be settled or payable within 1 year .

And long term liabilities are those liabilities which are to be settled or payable after 1 year.

Example of liabilities-

Accounts payable

Salary payable

Accrued wages

Income tax payable

Loans received

Notes payable etc

Contingent liabilities are the liabilities which are not sure in nature.

Contingent liabilities may or may not occur. It may occur in future on the occurance of some specific event.

A contingent liability that is both probable and the amount can be estimated is recorded as 1) an expense or loss on the income statement, and 2) a liability on the balance sheet. As a result, a contingent liability is also referred to as a loss contingency.

Example of contingent liabilities-.

Potential lawsuits

Product warranty

Some other points on contingent liabilities-

example a 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.