Contingent Liability is the potential loss, the occurrence of which is dependent on some unfavorable event and when such liability is likely and can be reasonably estimated, it is recorded as loss or expense in the statement of income.
Overview of Contingent Liability Journal Entry
The potential liabilities whose occurrence depends on the outcome of an uncertain future event are accounted as contingent liabilities in the financial statements. i.e. these liabilities may or may not rise to the company and thus considered as potential or uncertain obligations. Some common example of contingent liability journal entry includes legal disputes, insurance claims, environmental contamination, and even product warranties results in contingent claims.
As per IFRS contingent liability is defined as:
- A possible obligation depending on whether some uncertain future event occurs.
- A present obligation but payment is not probable or the amount cannot be measured reliably.
Rules to Record Contingent Liabilities as per IFRS
In order to record a potential or contingent liability in the financial statements, it needs to clear two basic criteria based on the probability of occurrence and its related value as discussed below:
- The likelihood of occurrence of contingent liability is high (i.e. more than 50%) and
- Estimation of the value of the contingent liability is possible.
Upon clearing these two fundamental criteria, the contingent liabilities will be journalized and recorded as:
- A loss or expense in the statement of profit and loss.
- Liability in the balance sheet.
But if chances of occurrence of a contingent liability are possible but are not likely to arise in near future, also estimating its value is not possible then such loss contingencies never gets recorded in the financial statements.
However, full disclosure should be made in the footnotes of the financial statements.