Contingent Liabilities

Contingent Liabilities Definition

Contingent Liabilities refers to the possible liability of the firm which may occur on some future date on basis of a contingent event that is beyond control of company. It is recorded by the company on its balance sheet only in case if it becomes evident that contingency is possible in company and amount of such liability can be estimated reasonably.

Understanding Contingent Liability

In simple words, Continent Liability is defined as the obligations or liabilities in the future, which may or may not arise due to uncertain events or situations. These liabilities are also recorded in the accounting books if the amount of the liability can be estimated.

These liabilities will be like if a person X obtains a loan from the Bank and Y is signed as a guarantee for that loan and the bank will release the funds based on that guarantee if the person X fails to repay the loan than the guarantee Y has to pay it, this, in turn, is referred to as contingent liability. They are generally not recognized as financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more or liabilities on the balance sheet before the conditions are met.

Contingent Liabilities

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Source: Contingent Liabilities (wallstreetmojo.com)

Some of the types of contingent liabilities are given below

#1 – Potential Lawsuits

Potential lawsuits arise when an individual gives the guarantee on the other person’s behalf when the actual person or individual fails to pay that the person who provided the guarantee must pay the money.

#2 – Product Warranty

When a product is manufactured and ready to sell than some companies give product warranty, i.e., a minimum guarantee for a certain period and when the product fails to perform within the warranty period than the product has to be replaced or repaired by the company which is a liability to the company.

Let us see the example where a person has purchased a motorcycle from a showroom and has a warranty for the engine and the motorcycle for two years, and the engine failed to work within six months of the purchase, then the company has to replace the engine. Hence, this is a contingent liability to the company.

#3 – Pending Investigations

Any pending investigation or a court case by law if found that the individual or the company is defaulter than they were supposed to bear the penalty as prescribed the court of law.

When to Record Contingent Liabilities?

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