What is a Contingent Liability? - Accounting Questions Answered

A contingent liability is, as the name suggests, contingent or dependent upon a future event and if that event happens or does not happen. For example, if a company thinks it will face a potential lawsuit in the future, this is a contingent liability because it could win the case, or lose it, if it happens. Another example is if your parents guarantee the mortgage on your home, then if you make all your payments on time and do not default on your mortgage, there is no contingent liability on your parents. If you fail to make the payments, your parents will incur a liability. Another example is when a company is sued for $50,000 by a former employee for harassment or discrimination; the company will have a contingent liability. If the company wins the case, they will not have a liability but if they lose, they will incur a liability.

In terms of accounting, a contingent liability and the related contingent loss is recorded in the books via a journal entry only if the liability is both probable AND the amount can be estimated fairly. If a contingent liability is possible (not probable), then no journal entry is required however, a disclosure in the annual report and financial statements of the company is mandatory. If a contingent liability happens to be a notorious 'slip and fall' claim, then most probably the company will not record a journal entry does it have to disclose this in the financial statements.

Merchandising companies that offer warranties on their products have to record an estimated warranty liability, and this is a good example of contingent liability because the chance of defective products is both probable, and can be estimated.

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