Contingent Liability: What Is It, and What Are Some Examples?

If the firm determines that the likelihood of the liability occurring is remote, the company does not need to disclose the potential liability. Under the generally accepted accounting principles (GAAP), contingent liabilities are recorded as actual liabilities only if the potential liability is probable and its amount can be reasonably estimated. Assume that Sierra Sports is sued by one of the customers who purchased the faulty soccer goals. A settlement of responsibility in the case has been reached, but the actual damages have not been determined and cannot be reasonably estimated. This is considered probable but inestimable, because the lawsuit is very likely to occur (given a settlement is agreed upon) but the actual damages are unknown. No journal entry or financial adjustment in the financial statements will occur.

Related IFRS Standards

Assume, for example, that a bike manufacturer offers a three-year warranty on bicycle seats, which cost $50 each. If the firm manufactures 1,000 bicycle seats in a year and offers a warranty per seat, the firm needs to estimate the number of seats that may be returned under warranty each year. A probable contingent liability that can be reasonably estimated is entered into the accounts even if the precise amount cannot be known. Furthermore, in many cases, the actual payee of the liability is not known until the future event occurs. A contingent liability is the result of an existing condition or situation whose final resolution depends on some future event.

IAS 37 — Changes in decommissioning, restoration, and similar liabilities

The accrual account permits the firm to immediately post an expense without the need for an immediate cash payment. If the lawsuit results in a loss, a debit is applied to the accrued account (deduction) and cash is credited (reduced) by $2 million. The ‘not-to-prejudice‘ exemption in IAS 37.92 also extends to contingent assets. Additionally, see the forum’s discussion regarding a scenario where a once-recognised contingent asset’s likelihood of resource inflow is no longer virtually certain.

• The recognition of contingent liabilities on the financial statements (and footnotes) is to present investors, lenders, and others with reliable financial statements that contain accurate, conservative information.
• Contingent assets are not recognised, but they are disclosed when it is more likely than not that an inflow of benefits will occur.
• Contingent liabilities are liabilities that depend on the outcome of an uncertain event.
• If no amount within the range is a better estimate, the minimum amount within the range should be accrued, even though the minimum amount may not represent the ultimate settlement amount.
• This liability is not required to be recorded in the books of accounts, but a disclosure might be preferred.

Applicability of Contingent liabilities in investing

• Contingent liabilities are incurred on a conditional basis, where the outcome of an uncertain future event dictates whether the loss is incurred.
• A contingent liability is not recognised in the statement of financial position.
• If a contingent liability is deemed probable, it must be directly reported in the financial statements.
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• The company would record this warranty liability of $120 ($1,200 × 10%) to Warranty Liability and Warranty Expense accounts.
• There is a probability that someone who purchased the soccer goal may bring it in to have the screws replaced.

There is a probability that someone who purchased the soccer goal may bring it in to have the screws replaced. Not only does the https://www.bookstime.com/articles/what-is-expense-management-automation meet the probability requirement, it also meets the measurement requirement. Examples of contingent liabilities are the outcome of a lawsuit, a government investigation, and the threat of expropriation. Although it is not realized in the books of accounts, a contingent liability is credited to the accrued liabilities account in the journal. Contingent liabilities are recorded on the P&L statement and the balance sheet if the probability of occurrence is more than 50%.

Product Recalls: Contingent Liabilities?

In such instances, the ‘virtually certain’ threshold is applicable before a disputed asset can be recognised. If the recognition criteria for a contingent liability are met, entities should accrue an estimated loss with a charge to income. If the amount of the loss is a range, the amount that appears to be a better estimate within that range should be accrued. If no amount within the range is a better estimate, the minimum amount within the range should be accrued, even though the minimum amount may not represent the ultimate settlement amount. Contingent assets are assets that are likely to materialize if certain events arise. These assets are only recorded in financial statements’ footnotes as their value cannot be reasonably estimated.

IFRS Foundation publishes tenth compilation of IFRS Interpretations Committee agenda decisions

• Furthermore, in many cases, the actual payee of the liability is not known until the future event occurs.
• Contingent liabilities are subject to continuous reassessment due to the possibility of their development differing from initial expectations.
• Historical data often serves as the precedent by which the percentage assumption is set, i.e. to estimate the future liability incurred for purposes of internal planning.
• Contingent liabilities must pass two thresholds before they can be reported in financial statements.
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But if neither condition is met, the company is under no obligation to report or disclose the contingent liability, barring unusual circumstances. Loss contingencies are accrued if determined to be probable and the liability can be estimated. But unlike IFRS, the bar to qualify as “probable” is set higher at a likelihood of 80%. On that note, a company could record a contingent liability and prepare for the worst-case scenario, only for the outcome to still be favorable. Banks that issue standby letters of credit or similar obligations carry contingent liabilities. All creditors, not just banks, carry contingent liabilities equal to the amount of receivables on their books.

Where Are Contingent Liabilities Shown on the Financial Statement?

IFRIC 1 — Changes in Existing Decommissioning, Restoration and Similar Liabilities