Recording a Contingent Liability
A potential or contingent liability that is both probable and the amount can be estimated is recorded as 1) an expense or loss on the income statement, and 2) a liability on the balance sheet.
Disclosing a Contingent Liability
A loss contingency which is possible but not probable will not be recorded in the accounts as a liability and a loss. Rather, it will be disclosed in the notes to the financial statements.
A loss contingency that is probable or possible but the amount cannot be estimated means the amount cannot be recorded in the company’s accounts or reported as liability on the balance sheet. Instead, the contingent liability will be disclosed in the notes to the financial statements.
Not Reporting or Disclosing a Contingent Liability
A loss contingency that is remote will not be recorded and it will not have to be disclosed in the notes to the financial statements. An example is a nuisance lawsuit where there is no similar case that was ever successful.
Example of Recording a Contingent Liability
Product warranties are often cited as a contingent liability that meets both of the required conditions (probable and the amount can be estimated). Product warranties will be recorded at the time of the products’ sales by debiting Warranty Expense and crediting to Warranty Liability for the estimated amount.
