The word contingent or contingency means “possible, but not certain to occur”. So, according to the definition, contingent liabilities are those liabilities that may or may not be incurred by a business depending on the outcome of a future event. The existence of this kind of liability is completely dependent on the occurrence of a probable event in future.
An example of such liability is a court case, only if the company loses the court case, contingent liability will actually be realized. In another example of contingent liabilities acting as a surety/guarantor on a loan and assuming the responsibility of paying it back in case of default may also be a case of contingent liability since if the principal debtor fails to pay you will be required to reimburse.
Unlike contingent assets, contingent liabilities are required to be disclosed as soon it can be estimated, usually as a footnote to the balance sheet. If the possibility of the outflow of money or assets is remote then the disclosure may not be necessary.
There are two questions that need to be answered if a contingent liability is to be recorded with a journal entry:
- Is the contingent liability probable?
- Can the amount of obligation be estimated?
Patent wars that usually happen between Top brands give a clear-cut explanation. Let’s suppose that Apple files a case of a patent violation on Samsung and Samsung not only realizes that it may have to pay for violations but also estimates how much in total. In this case, Samsung will record the estimated amount in their books of accounts as a Contingent Liability.