Contingent liability is a potential liability that may become an actual liability in the future.
Using the following guidelines, companies should report contingent liabilities:
- If the contingency is probable (if it is likely to occur) and the amount can be reasonably estimated, the liability should be recorded in the accounts.
- If the contingency is only reasonably possible (if it could happen), then it need to be disclosed only in the noted that accompany the financial statements.
- If the contingency is remote (if it is unlikely to occur), it need not be recorded or disclosed.
Prouduct warranties are an example of a contingent liability that companies should record in the accounts. Warranty contracts result in future costs that companies may incur in replacing defective units or repairing malfunctioning units.
Contingent liability arising out of work done by independent contractors for a firm. A firm may be liable for the work done by an independent contractor if the activity is illegal, the situation does not permit delegation of authority, or the work is inherently dangerous.
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