Examples of Contingent Liabilities
Potential liability of company which depends on the happening or non-happening of some contingent event in the future which is beyond the company’s control of company is known as the contingent liability and the example of which includes potential pending lawsuits of the company, warranties given, etc.
Most common examples of Contingent Liabilities are given below –
- Product Warranty
- Pending Investigation or Pending Cases
- Bank Guarantee
- Lawsuit for theft of Patent/know-how
- Change of Government Policies
- Change in Foreign Exchange
- Liquidate Damages
Let us discuss each one of them in detail –
Top 8 Most Common Examples of Contingent Liability
#1 – Lawsuit
A customer has filed a lawsuit against the company of $100 for deficiency in the product and customer service and due to which customer has suffered a lot. The company legal department believes that the customer has strong evidence to prove his case, and there is a chance that the customer will win this case.
In the above case, there is a possibility that the company may lose this case, and liability of $100 will arise since both the conditions are satisfied; therefore, the company will record this liability in the financial statementFinancial StatementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. by debiting the legal expenses and credit the accrued expensesAccrued ExpensesAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited..
If in the above example company has a reason to believe that the customer will not win this case and the company has all the evidence then, in that case, this will be reported in notes of accounts of financial statements.
#2 – Product Warranty
Some companies are providing a warranty on its product, suppose a company X ltd. Selling a car and providing 3 years of warranty on the engine of the car which cost is around $1000. If the company is selling 5000 units, then the company has to estimate how many cars may come for engine replacement during the warranty period, and accordingly, the company has to provide contingent liabilityContingent LiabilityContingent Liabilities are the potential liabilities of the company that may arise at some future date as a result of a contingent event that is beyond the company's control. in their financial statements.
Assume in the above example company estimates that 25%, i.e., 1250 units car will come for replacement of engine than the company has to provide (1250*$1000) as a contingent liability.
#3 – Pending Investigation or Pending Cases
If there is any pending investigation, pending court cases, and pending assessment of income tax or any other tax, then the company has to disclose contingent liability in his books of accounts.
#4 – Bank Guarantee
There are two companies; one is X Ltd, and the second is Y Ltd. Suppose Y Ltd. Is taking a loan of $1000 million and X ltd. Is giving a guarantee on behalf of Y Ltd. In that case, if Y ltd fails to make a payment, then X ltd has to make the payment to the bank; therefore, X Ltd has to disclose this contingent liability in their books of accounts.
#5 – Lawsuit for theft of Patent/know-how
Suppose ABC Ltd is a pharmaceutical company and they are developing one formula of medicine which cures diabetes at the same time another pharmaceutical company like XYZ ltd files a lawsuit against ABC ltd of $1000 million for theft of its patent/know-how, and ABC ltd feels that they will lose the lawsuit and they have to make payment to XYZ Ltd. In that case, ABC ltd record, the contingent liability in his books of accounts.
#6 – Change of Govt. Policies
If a company has a reason to believe there will be a change in government policies due to which their cost of the product becomes costlier, or there is a change in rates of taxes or there is a chance to take further approval, or they have to spend some percentage of profit to the welfare fund of the govt. In that scenario, the company has to disclose and give a note on contingent liability in their notes of account of financial statements.
#7 – Change in Foreign Exchange
Suppose a company is doing import-export business like they are procuring raw material from one country, and they are supplying finished goods to the other country. In that case, the company has to make payment in foreign currency, and because of global economic conditions there may be a chance that rates of foreign currency will increase, and the company has to make more payment to its creditors compare to its actual cost then the company has to record a contingent liability in his books of accounts but at the same time company will receive more money from its debtorsDebtorsA debtor is a person or entity that owes money to the other party in a transaction. The receiver is referred to as the creditor, and the payment terms vary for each transaction based on the terms and conditions agreed upon by the parties. also compare to its selling price but they will not record this contingent asset in their books of accounts because of accounting principles.
#8 – Liquidate Damages
Liquidity damages is an amount of money agreed upon by parties under a contract which one will party will pay to others upon breaching of contract. The non-defaulting may file a case and obtain a judgment for the number of liquidated damages; on the other hand, the defaulting party may record/disclose a contingent liability in his books of accounts.
This has been a guide to Contingent Liability examples. Here we discuss the top 8 most common examples of contingent liabilities along with detailed explanations. You can learn more about Accounting from the following articles –