Contingent Liabilities are potential OBLIGATIONS that may or may not come into existence, depending on the occurrence or non-occurrence of one or more future events that are not entirely within the control of the entity. They are often referred to as “Off-Balance Sheet” items because they are not reflected in the balance sheet of an entity as either an asset or a liability.
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Contingent Liabilities Examples
They can arise from a variety of sources, such as lawsuits, guarantees, and contracts. e.g, a company may have a contingent liability if it has given a guarantee on a loan taken by one of its customers, or if it has entered into a contract to provide a product or service that is dependent on certain conditions being met.
One of the primary CHALLENGES is the difficulty in estimating their potential impact. Since the event that would trigger the liability may or may not occur, it can be difficult to determine the amount of the potential liability. In addition, the timing of the event can also be uncertain, making it difficult to determine when, or if, the liability will arise.
Contingent Liabilities – Are they Liabilities?
As per IAS 37, these are potential obligations that may or may not come into existence.
Despite the uncertainty surrounding contingent liabilities, it is important for entities to recognize and manage them, as they can have a significant impact on the financial position and performance of the entity. e.g, a large contingent liability can reduce the liquidity of an entity, making it difficult for it to meet its obligations as they come due. It can also have a NEGATIVE impact on the credit rating of an entity, making it more difficult and expensive to obtain financing.
To MANAGE contingent liabilities, entities should have processes in place to identify, evaluate, and monitor them. This can involve regularly reviewing contracts and agreements to identify potential contingent liabilities, as well as regularly reviewing legal and regulatory developments that could trigger liability. In addition, entities should consider obtaining insurance to mitigate the potential impact of certain types of contingent liabilities, such as lawsuits.
When EVALUATING a contingent liability, entities should consider a number of factors, including the likelihood of the event occurring, the potential impact of the event, and any actions that can be taken to mitigate the impact. e.g, an entity may decide to settle a lawsuit in order to reduce the potential impact of a contingency liability.
1. Accounting (As Per IAS 37)
As per International Accounting Standard (IAS 37), Contingent Liabilities are required to be DISCLOSED in the financial statements if they are BOTH probable and can be reliably estimated.
If a contingent liability is NOT both probable and estimated, it does not need to be reflected in the financial statements.
The Bottom Line
Contingent Liabilities are potential obligations that can have a SIGNIFICANT impact on the financial position and performance of an entity. To effectively manage them, entities should have processes in place to identify, evaluate, and monitor them, and should consider obtaining insurance to mitigate their potential impact.
When EVALUATING a contingent liability, entities should consider factors such as the likelihood of the event occurring and the potential impact of the event. Ultimately, by ‘Recognizing’ and ‘Managing’ contingent liabilities, entities can take steps to reduce the potential impact of these obligations on their financial performance and position.
Chartered Accountant (Institute of Chartered Accountants of Pakistan)
Bachelor of Accounting Honours (Asia e University, Malaysia)