Define the term "contingent liability" and discuss the criteria used to classify these events or conditions. Provide some examples of contingent liabilities.

Question

What will be an ideal response?

Answer 1

A contingent liability is defined as an existing condition, situation, or set of circumstances involving uncertainty as the possible loss to an entity that will ultimately be resolved when some future event occurs or fails to occur. FASB ASC Topic 450, "Contingencies," states that when a contingent liability exists, the likelihood that the future event will result in a loss or impairment of an asset or the incurrence of a liability can be classified into three categories:

1. Probable. The future event is likely to occur. If the event is probable and the amount of the loss can be reasonably estimated, the loss is accrued by a charge to income.

2. Reasonably possible. The chance of the future event occurring is more than remote but less than likely. When the outcome of the event is judged to be reasonably possible or the amount cannot be estimated, a disclosure of the contingency is made in the footnotes to the financial statements.

3. Remote. The chance of the future event occurring is slight. In general, loss contingencies that are judged to be remote are not disclosed in the footnotes.

Examples of contingent liabilities include: pending or threatened litigation, actual or possible claims and assessments, income tax disputes, product warranties or defects, guarantees of obligations to others, and agreements to repurchase receivables that have been sold.