If a company is sued by a former employee for $500,000 for age discrimination, the company has a contingent liability. If the company is found guilty, it will have a liability. However, if the company is not found guilty, the company will not have an actual liability.
In accounting, a contingent liability and the related contingent loss are recorded with a journal entry only if the contingency is both probable and the amount can be estimated.
If a contingent liability is only possible (not probable), or if the amount cannot be estimated, a journal entry is not required. However, a disclosure is required.
When a contingent liability is remote (such as a nuisance suit), then neither a journal nor a disclosure is required.
A product warranty is often cited as a contingent liability that is both probable and can be estimated. Additional examples and a further explanation are presented in FASB's Statement of Financial Accounting Standards No. 5, Accounting for Contingencies. This accounting pronouncement is available at www.FASB.org/st.
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