Definition of Commitments and Contingencies
Commitments and contingencies is a balance sheet line with no amount reported. The line generally appears between the liabilities and stockholders’ equity sections to direct a reader’s attention to the disclosures included in the notes to the financial statements.
Commitments are likely legal binding agreements for future transactions. If no amount is currently payable, there is no liability amount reported but readers must be informed of items that are significant in amount.
Contingencies refer to potential or contingent liabilities and losses. These are reported in the notes to the financial statements (instead of a general ledger account) because the amount might not be determinable or the liability is possible but not probable. Generally, gain contingencies are not disclosed.
Examples of Commitments and Contingencies
A chain of retail stores may have signed five-year, noncancelable leases to rent retail space for $1 million per year. This significant commitment must be disclosed to the readers of the balance sheet. However, if the $5 million pertains to future dates, there is no liability amount to be reported on the current balance sheet.
Another example of a commitment is an electric utility’s noncancelable contract to purchase 100 million tons of coal during the following 10 years. This significant commitment must also be disclosed to the readers of the balance sheet. However, if none of the coal has been delivered as of the balance sheet date, the utility company will not report a liability amount.
Companies will often have some contingent liabilities, which are not recorded in the general ledger because the liability and loss may or may not become a liability. Unless the liability/loss is remote, if the item is signicant, it must be disclosed.
An example of a contingent liability is a company’s guarantee of its key supplier’s bank loan. No liability amount is reported on the company’s balance sheet because the supplier’s loan payments are current and the supplier is operating profitably. If the company is named in a lawsuit, but the loss and liability is possible, it should be disclosed in the company’s notes to the financial statements. (If the loss is remote, it does not get disclosed. If the loss is probable and the amount can be estimated, it should be recorded in the accounts and the amount of the liability reported on the balance sheet.)
