A liability that may arise as a result of a future scenario that is undetermined is called contingent liability. If such contingency is anticipated and the extent of the liability can be adequately determined, a contingent liability is recorded in the accounting records.
Unless these conditions have been met, the liability may be reported in the financial statements’ footnote. A product warranty, as well as debts and pending lawsuits, are common examples of contingent liabilities.
Recognizing A Contingent Liability:
The three types of contingent liabilities recognized by Generally Accepted Accounting Principles (GAAP) are probable, reasonably possible, and remote.
Probable – The term “probable” refers to the likelihood of a future event happening. In this case, contingent Liability will only be recorded if the loss is likely to happen and the amount of loss may be reasonably estimated. As result, they appear in the financial statements as liabilities.
Reasonably Possible – whenever a liability can be estimated justifiably but not probable, it is recognized as a contingent liability. These come in the form of notes since the amount cannot be determined with accuracy. “Reasonably possible” implies that the likelihood of an event occurring is greater than remote but less than certain.
Remote – if the likelihood of its occurrence is remote and the likelihood of future settlement is minimal, the contingent liability is not recorded or disclosed. The term “remote” here refers to situations that are not really likely to happen and aren’t realistic and achievable.