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
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 soon, also estimating its value is not possible, then such loss contingencies never get recorded in the financial statements.
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However, full disclosure should be made in the footnotes of the financial statements.
How to Recording a Contingent Liability Journal Entry?
Let’s see some simple examples of the contingent liability journal entry to understand it better.
Taking the example of a famous lawsuit of Apple vs. Samsung, where Apple sued Samsung for technology theft and violating patent rights. Apple claimed $2.5 billion when the lawsuit began in 2011 but won over $500 million in the final verdict in 2018.
The lawsuit was considered as a contingent liability in the books of Samsung ltd an estimated value of $700 million.
- Prepare journal entries for the year ending 2011, assuming it is probable that Samsung will be liable to pay an amount of $700 million.
- Prepare journal entries for the year ending 2011, assuming it is not probable that Samsung will be liable to pay any amount.
- Considering no other pending lawsuits prepare journal entries for the year ending 2018, where Samsung lost the lawsuit and has to pay $500 million.
#1 – The Amount is Estimated, and the likelihood of Occurrence is High
#2 – The Probability of Occurrence is Very Less or Nil
- Journal entries will not be passed. The loss is not accrued because it is not probable that liability will arise soon.
- Full disclosure should be made in the footnotes of the financial statements because liability might not arise shortly, but there is a possibility of its occurrence in later years.
#3 – Payment of Lost Lawsuit
The ledger of lawsuit liability for the year ending 2011 and 2018
This article has been a guide to Contingent Liability Journal Entry. Here we discuss rules to record contingent liabilities along with practical examples. You can learn more about accounting from the following articles –