In the day to day business, we can encounter some transactions whose final outcome will not be known. Some of the examples of such transactions can be insurance claims, oil spills, lawsuits. All these create a liability for the company and liabilities that are created in such situations are known as contingent liabilities.
What is Contingent Liability
Contingent liabilities are defined as those potential liabilities that may occur in a future date as a result of an uncertain event that is beyond the control of the business. A contingent liability will only be recorded in the balance sheet when the probability of its occurrence is certain, and the extent of such liability can be determined.
In simple words, contingent liabilities are those obligations that will arise in future due to certain events that took place in the past or will be taking place in future.
The most common contingent liabilities examples are outstanding lawsuits, debts, product warranties, pending investigations etc.
Types of Contingent Liabilities
Contingent liabilities are of two types which are:
1. Explicit Contingent Liabilities
2. Implicit Contingent Liabilities
Let us know more in details about the types
Explicit Contingent Liabilities: These liabilities are specific types of obligations that are created by government or obligations which are legal in nature that are established by the law.
Some of the examples are:
i. Government insurance schemes on pension funds, bank bonds or bank deposits.
ii. Student loan, mortgage loan
iii. Currency exchange rates
iv. Legal claims in which court orders to pay the penalty for pending cases.
Implicit Contingent Liabilities: These types of liabilities are legal obligations that are identified after the occurrence of an event. Government sets the amount for the liability in such cases. They are not recorded in the books as these events may occur or may not occur.
Some examples are:
1. Disaster relief fund for people affected by natural disaster.
2. Failure of the central bank on paying its obligations like the balance of payment
3. Social security
Let us discuss some of the contingent liabilities’ examples
1. Product Warranty: This is one of the most common types of contingent liability examples. It occurs when a company launches a product with a warranty period with the condition that if the product fails to work within the period, it has to be repaired or replaced which becomes a liability for the company.
2. Lawsuits: Lawsuits are legal proceedings by an individual, party or parties against another in the civil court of law.
3. Pending Investigations: If an individual or company is found to be defaulting in any form of payment, then they have to pay fine or penalty as ordered by the court.
Recording of Contingent Liabilities
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. Therefore, no accounting treatment exists for contingent liabilities.
But as accounting follows a conservative approach, there must be disclosure, and therefore contingent liability needs to be updated in final statements of the company in the form of footnotes. Such disclosure is made only when there is an obligation from a past event, and the amount of the liability can be measured reasonably.
Difference between Provision and Contingent Liability
Provisions are a sum of money that is set aside in order to cover a probable expense that will happen in future. In this case, the obligation is already present, but the amount for such an obligation cannot be determined exactly.
Contingent liabilities are liabilities that are uncertain expenses that may or may not happen in future, but companies maintain it in order to encounter future uncertainties.
Provisions are recorded in the accounts. They get debited in Profit and Loss accounts whereas contingent liabilities are recorded as footnotes in financial
This is all about the contingent liabilities. It will help students develop an understanding of the concept of contingent liabilities. For more such intriguing concepts, stay tuned to BYJU’S.