Contingent Liability

What is Contingent Liability?

In layman's language, a Liability is an obligation! And contingent is a condition, which is not certain. So, when we say Contingent Liability, it is actually a potential liability. This may turn into a liability or may not! It depends on a certain condition, that's going to take place in future.

Example of Contingent Liability

Let's understand this further with an example. The company is fighting a legal battle for an amount of one million, which is filed on him by some third party vendor. The petitioner argued that, the company should pay the amount of one million as service paid by the vendor. However, the company insists that because of low quality and delayed turn around time, the penalty cause of agreement comes into effect which compensates the service amount. Now, if the company won the case, he need not pay the amount but if it loses the case he has to pay bear this liability. So, this will be treated as a contingent liability.

Warranty is another good example of Contingent Liability!

How to treat a Contingent Liability in Balance Sheet

Now there are two types of Contingent Liability; one where the amount of liability can be ascertained. Suppose it is a loss contingency and the amount is ascertainable than it can be shown as an expense on the Profit and Loss account. And also as a liability on the Balance Sheet. However, if the amount can't be ascertained; than it should not be recorded in the Balance Sheet or P&L account. Instead, it will be shown as a disclosure in the notes to financial statement.

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