- By Sheraz
- November 22, 2025
Moreover, coordinating with the fiscal service can aid in managing any subsequent transaction updates that relate to contingent liabilities to ensure accuracy in financial representation. Navigating the murky waters of contingent liabilities, Nick clarifies when and how to handle potential financial obligations that hinge on uncertain future events. He uses practical examples, like lawsuits and natural disasters, to explain the conditions under which a company would record a journal entry.
Assume, on the other hand, ABC Company’s settlement amount was likely to be between $1 million and $2 million– but no specific amount within that range is more likely than any other. In that case, the company should record the minimum of the range as its contingent liability. It would record a journal entry to debit legal expense for $1 million and credit an accrued liability account for $1 million. Contingent liabilities are a type of liability that may be owed in the future as the result of a potential event. In this journal entry, lawsuit payable account is a contingent liability, in which it is probable that a $25,000 loss will occur. This leads to the result of an increase of liability (credit) by $25,000 in the balance sheet.
IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets. If the contingent contingent liability journal entry liability is considered remote, it is unlikely to occur and may or may not be estimable. This does not meet the likelihood requirement, and the possibility of actualization is minimal. In this situation, no journal entry or note disclosure in financial statements is necessary.
Reversing entries can be set to automatically reverse in a future period, thereby eliminating this risk. An adjusting journal entry involves an income statement account (revenue or expense) along with a balance sheet account (asset or liability). It typically relates to the balance sheet accounts for accumulated depreciation, allowance for doubtful accounts, accrued expenses, accrued income, prepaid expenses,deferred revenue, and unearned revenue. Income statement accounts that may need to be adjusted include interest expense, insurance expense, depreciation expense, and revenue. Accruals are revenues and expenses that have not been received or paid, respectively, and have not yet been recorded through a standard accounting transaction. Deferrals refer to revenues and expenses that have been received or paid in advance, respectively, and have been recorded, but have not yet been earned or used.
As you’ve learned, not only are warranty expense and warranty liability journalized, but they are also recognized on the income statement and balance sheet. The following examples show recognition of Warranty Expense on the income statement (Figure) and Warranty Liability on the balance sheet (Figure) for Sierra Sports. An example of determining a warranty liability based on a percentage of sales follows. The sales price per soccer goal is $1,200, and Sierra Sports believes 10% of sales will result in honored warranties.
Contingent liabilities are categorized based on the likelihood of the event occurring and whether the amount of loss can be reasonably estimated. Understanding the types of contingent liabilities helps businesses determine how and when to recognize or disclose such liabilities. Contingent liabilities are only recorded in financial statements if the loss is probable and the amount is reasonably estimable.
Here, Rey Co would capitalise the $170m as part of property, plant and equipment. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. In addition to this, the discount on the provision will be unwound and debited to interest expenses on unwinding of discounts. Consequently, the provision will increase each year until it becomes $20m at the end of the asset’s 25-year useful life. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m.
For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Consider reimbursements and account for them as separate assets only when virtually certain.
For example, Sierra Sports has a one-year warranty on part repairs and replacements for a soccer goal they sell. Sierra Sports notices that some of its soccer goals have rusted screws that require replacement, but they have already sold goals with this problem to customers. There is a probability that someone who purchased the soccer goal may bring it in to have the screws replaced.
Contingent liabilities are potential obligations that may arise from past events, but their existence depends on the occurrence of one or more uncertain future events. In summary, companies must disclose all material contingent liabilities in their financial statements and notes. They must also follow the appropriate measurement requirements under GAAP or IFRS.
In other words, if there is no past event, then there is no liability and no provision should be recognized. A liability is a present obligation arising from past event that is expected to be settled by an outflow of economic benefits from an entity. In fact, manipulation of profit figure by making and releasing various provisions back and forth was very popular “creative accounting practice” in the past.
The events are not under the control of the company, so the company cannot decide on the occurrence of the event. A provision is measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. In short, there is a diversity of treatment for the debit side of liability accounting. X, Y and Z entered into a partnership and contributed ₹ 9,000; ₹ 6,000 and ₹ 3,000 respectively. The business lost heavily during the very first year and they decided to dissolve the firm. After realising all assets and paying off liabilities, there remained a cash balance of ₹ 6,000.
Deferred expenses are expenses that have been paid in advance and will be expensed out at a later date. Liquidity and solvency are measures of a company’s ability topay debts as they come due. Liquidity measures evaluate a company’sability to pay current debts as they come due, while solvencymeasures evaluate the ability to pay debts long term. One commonliquidity measure is the current ratio, and a higher ratio ispreferred over a lower one. This ratio—current assets divided bycurrent liabilities—is lowered by an increase in currentliabilities (the denominator increases while we assume that thenumerator remains the same).
Otherwise, they are disclosed in the notes or omitted entirely, depending on the likelihood and measurability. Learning how contingent liabilities are defined, reported, and addressed under accounting standards such as GAAP and IFRS may help businesses stay transparent and prepared for possible financial risks. ABC Company’s legal team believes the chance of a negative outcome for ABC is probable. They estimate the potential legal settlement to be between $1 million and $2 million– with the most likely settlement amount being $1.25 million. In this case, the company should record a contingent liability on the books in the amount of $1.25 million.
However, the company should disclose the contingent liability information in its footnotes to the financial statements if the financial statements could otherwise be deemed misleading to financial statement users. But if chances of a contingent liability are possible but are not likely to arise soon, estimating its value is not possible. The liability should not be reflected on the balance sheet if the contingent loss is remote and has less than a 50% chance of occurring. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements. Contingent liabilities are those that depend on the outcome of an uncertain event. Categories of contingent liabilities under GAAP include probable, possible, and remote.
To record a contingent liability, an entity should debit an expense account and credit a liability account if the liability’s occurrence is probable and can be estimated. This is based on the IFRS criteria, which states that the likelihood of occurrence must be high (more than 50%) and the value must be estimable. A contingent liability is a type of liability that may occur in the future due to an event that has already taken place.
For example, suppose a company has a $1,000 debit balance in its supplies account at the end of a month, but a count of supplies on hand finds only $300 of them remaining. When a transaction is started in one accounting period and ended in a later period, an adjusting journal entry is required to properly account for the transaction. Adjusting journal entries can also refer to financial reporting that corrects a mistake made previously in the accounting period. The purpose of adjusting entries is to accurately assign revenues and expenses to the accounting period in which they occurred. If companies use the same cash method of accounting for both financial and tax reporting, the completed journal entries include an equal debit and credit to income tax expense and income tax payable, respectively.
