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LogoutA contingent liability is an obligation that may arise as a result of the outcome of a future event that is unknown. If the contingency is foreseeable and the amount of the responsibility can be fairly anticipated, a contingent liability is recorded. Unless all requirements are satisfied, the liability may be reported in a footnote to the financial statements.
Assume that a corporation is being sued for patent infringement by a competitor. The legal department of the corporation believes the competitor firm has a solid case, and the company forecasts a $2 million loss if the firm loses. The company puts an accounting item on the balance sheet to debit (raise) legal expenditures by $2 million and credit (increase) accrued expense by $2 million since the liability is both likely and straightforward to estimate.
The accrual account allows the company to report an expenditure without having to make a cash payment right away. If the case ends in a loss, the accumulated account (deduction) is debited, and the cash account is credited (reduced) by $2 million.
Assume that a lawsuit is a possibility but not a certainty, and that the cost is projected to be $2 million. In these cases, the firm discloses the contingent obligation in the financial statements’ footnotes. If the firm decides that the chance of the liability happening is remote, the possible liability does not need to be disclosed.