5. Contingent Liabilities

This section explains how to account for contingent liabilities.

What is a contingent liability?

A potential obligation that depends on a future event arising from a past transaction or event.

What is an example of a contingent liability?

A pending lawsuit. Here, a past transaction or event leads to a lawsuit whose financial outcome depends on the result of the suit.

What does accounting for contingent liabilities depend on?

Depends on the likelihood that a future event will occur and the ability to estimate the future amount owed if this event occurs.

Review figure 11.5 under Accounting for Contingent liabilities.

When do we record the liability?

If the future event is probably (likely) and the amount owed can be reasonably estimated.

What are examples of when you would record the liability (if the liability is contingent)?

Warranties, vacation pay, and income taxes.

What is the entry to record the liability?

debit Estimated Expense, credit Estimated Liability

When do we need a note disclosure?

The future event is reasonably possible (could occur).

When do we not need a disclosure or to record the liability>

The future event is remote (unlikely).

Review 

A contingency is an if. Namely, if a future event occurs, then financial consequences are likely for the entity.

Many companies are sued or at risk of being sued. What is the accounting issue related to this?

Whether the defendant (the company) records a liability or discloses a contingent liability in its notes while a lawsuit is outstanding and not yet settled.

When should a company record the liability if they are sued or at risk of being sued?

A potential claim is recorded only if payment for damages is probable and the amount can be reasonably estimated.

When should a company disclose the liability if they are sued or at risk of being sued?

If the potential claim cannot be reasonably estimated but is reasonably possible, it is disclosed.

What is a debt guarantee?

When a company guarantees the payment of debt owed by a supplier, customer, or another company.

Where does the guarantor usually disclose the debt guarantee?

In its financial statement notes as a contingent liability.

If it is probable that the debtor will default, what does the guarantor report the guarantee as?

Guarantor reports the guarantee as a liability.

What are examples of other contingencies?

Environmental damages, possible tax assessments, insurance losses, and government investigations.

What are examples of uncertainties that are not contingencies?

All organizations face uncertainties from future events such as natural disasters and new technologies.

Why are uncertainties such as future events of natural disasters and new technologies not contingent liabilities?

Because they are future events not arising from past transactions. Accordingly, they are not disclosed.

Review Need-To-Know 11-4