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 statementsFinancial StatementsFinancial 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.. 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 liabilityCommon Example Of Contingent LiabilityContingent liability example can help you understand the obligations which may result from uncertain forthcoming events that are not in the organization's control, like a lawsuit or change in government policy. journal entry includes legal disputes, insurance claimsInsurance ClaimsAn insurance claim refers to the demand by the policyholder to the insurance provider for compensating losses incurred due to an event covered by the policy. The company either validates or denies the claim based on their assessment and nature of the incurred losses., environmental contamination, and even product warranties results in contingent claims.
As per IFRS 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. 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.
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 ledgerThe LedgerLedger in Accounting, also called the Second Book of Entry, is a book that summarizes all the journal entries in the form of debits & credits to use for future reference & create financial statements. 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 –