Check out Google’s contingent liability considerations in this press release for Alphabet Inc.’s First Quarter 2017 Results to see a financial statement package, including note disclosures. A contingent liability is a potential expense that is not certain to occur in the future, and a company must satisfy a particular set of conditions before realizing the liability. Generally accepted accounting principles include guidelines on the recognition, measurement and reporting of contingent liabilities. Each liability is treated differently based on the likelihood of the contingency occurring. Warranty costs, coupons, injury claims and lawsuits are some common examples of contingent liabilities. A contingent liability is a liability that may occur depending on the outcome of an uncertain future event.
What are some examples of contingent liabilities?
Some examples of contingent liabilities include product warranties, environmental remediation costs, and litigation settlements.
The disclosure should include an estimate of the amount of the contingent loss or an explanation of why it can’t be estimated. Financial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period .
How to Avoid Contingent Liabilities
It provides quantitative indicators covering 12 areas of the business environment in 190 economies. The goal of the Doing Business series is to provide objective data for use by governments in designing sound business regulatory policies and to encourage … On receipt of this information, the Accounts Division will then review to ensure that it is accurate and complete, and supported by relevant documentation. The review conducted by the Accounts Division should contingent liabilities include a comparison between prior and current year measurement. Once expenses have been identified, the Accounts Division should ensure that these expenses are relevant to the provision raised. Whether the correct split of payments between current and non-current portions has been made. Building on the review of responses in section C above, it is vital that the Accounts Division is able to conclude on the final accounting treatment for the items raised.
Acquired contingencies are recorded based on an estimate of actual value. A contingent liability is a potential obligation that depends on the occurrence or non-occurrence of one or more events in the future. If the event occurs, the company may be required to make a payment; if it does not occur, the company will not be required to make a payment. Above indicates relevant stakeholders that may be responsible to provide information on provisions, contingent liabilities and contingent assets as part of the Accounts Division information request and review process. Assume in the year following the sale that repairs costing $13,000 are made for these customers at no charge. The expense has already been recognized in the year of sale so the payments made by the company serve to reduce the recorded liability.
Do Not Disclose a Contingent Liability
Since the company has a three-year warranty, and it estimated repair costs of $5,000 for the goals sold in 2019, there is still a balance of $2,200 left from the original $5,000. However, its actual experiences could be more, the same, or less than $2,200. If it is determined that too much is being set aside in the allowance, then future annual warranty expenses can be adjusted downward. If it is determined that not enough is being accumulated, then the warranty expense allowance can be increased. There are sometimes significant risks that are simply not in the liability section of the balance sheet. Most recognized contingencies are those meeting the rather strict criteria of “probable” and “reasonably estimable.” One exception occurs for contingencies assumed in a business acquisition.
Rather, a liability (such as “unearned revenue” or “gift card liability”) is reported to indicate that the company has an obligation to the holder of the card. As might be expected, determination as to whether a potential payment is probable can be the point of close scrutiny when independent CPAs audit a set of financial statements. The line between “probable” and “not quite probable” is hardly an easily defined benchmark. A debt that is expected to be satisfied within one year from the date of the balance sheet is classified as a current liability.In upper-level accounting courses, the definition of a current liability is refined a bit. It refers to any liability that will require the use of a current asset or the creation of another current liability.
Reversing of Provisions
To illustrate, assume that a retail store sells ten thousand refrigerators during Year One for $400 cash each. The product is covered by a warranty that extends until the end of Year Three. No claims are made in Year One but similar programs in the past have resulted in repairs being made to 3 percent of the refrigerator at an average cost of $90. Thus, this warranty is expected to cost a total of $27,000 (ten thousand units × 3 percent or three hundred claims × $90 each). Immediate recognition is appropriate because the loss is both probable and subject to reasonable estimation. Many companies utilize such programs on an ongoing basis so that data from previous offers will be available to help determine the amount of the expected loss.
The opinions of analysts are divided in relation to modeling contingent liabilities. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), its global network of member firms and their related entities. DTTL (also referred to as “Deloitte Global”) and each of its member firms are legally separate and independent entities. Total liabilities are the combined debts, both short- and long-term, that an individual or company owes. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts.
Sierra Sports may have more litigation in the future surrounding the soccer goals. These lawsuits have not yet been filed or are in the very early stages of the litigation process. Since there is a past precedent for lawsuits of this nature but no establishment of guilt or formal arrangement of damages or timeline, the likelihood of occurrence is reasonably possible. Since the outcome is possible, the contingent liability is disclosed in Sierra Sports’ financial statement notes. “Reasonably possible” means that the chance of the event occurring is more than remote but less than likely. The accounting rules for the treatment of a contingent liability are quite liberal – there is no need to record a liability unless the risk of loss is quite high.
- The Accounts Division should maintain an excel sheet containing the key details regarding each significant non-adjusting event requiring disclosure.
- If both of those conditions cannot be met, the contingent liability could be inserted in the footnote of a financial statement.
- When damages have been determined, or have been reasonably estimated, then journalizing would be appropriate.
- Describe the criteria that apply in accounting for contingencies.How does timing of events give rise to the recording of contingencies?