Contingent Liabilities Meaning & Types
Contingent assets are not recognised, but they are disclosed when it is more likely than not that an inflow of benefits will occur. However, when the inflow of benefits is virtually certain an asset is recognised in the statement of financial position, because that asset is no longer considered to be contingent. Contingent liabilities must pass two thresholds before they can be reported in financial statements.
Even if the outcome is based on the probability of occurrence of the event, it is considered an actual liability. But it will be recorded in the books only if the probability is more than 50%. When the probability of such an event is extremely low, it is allowed to omit the entry in the books of accounts, and disclosure is also not required. It can be recorded only if estimation is possible; otherwise, disclosure is necessary.
Medium Probability of Loss
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Contingent liabilities adversely impact a company’s assets and net profitability. Contingent liabilities do not get recorded in the financial statements of a company. These are obligations that are yet to occur, but there is a probability that it may occur in future.
Contingent Liabilities Accounting Treatment (U.S. GAAP)
Under U.S. GAAP accounting standards (FASB), the reported contingent liability amount must be “fair and reasonable” to not mislead investors or regulators. Based on the outcome of the underlying event that is set to occur in the future, the financial obligation can be “triggered” and cause the company to be held accountable to issue a conditional payment (or fee). Therefore, it is also important to describe the liability in the footnotes that accompany the financial statements. Here, it becomes necessary to notify it to shareholders and other users of financial statements because the outcome will have an impact on investment related decisions.
In addition, entities should consider obtaining insurance to mitigate the potential impact of certain types of contingent liabilities, such as lawsuits. Contingent Liabilities are potential OBLIGATIONS that may or may not come into existence, depending on the occurrence contingent liabilities example or non-occurrence of one or more future events that are not entirely within the control of the entity. They are often referred to as “Off-Balance Sheet” items because they are not reflected in the balance sheet of an entity as either an asset or a liability.
Reporting Requirements of Contingent Liabilities and GAAP Compliance
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- Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity.
- If the possibility of the outflow of money or assets is remote then the disclosure may not be necessary.
- Contingent liabilities are a type of liability that may be owed in the future as the result of a potential event.
- If the contingent loss is remote, meaning it has less than a 50% chance of occurring, the liability should not be reflected on the balance sheet.
- Some examples of such liabilities would be product warranties, lawsuits, bank guarantees, and changes in government policies.