What are Contingent Liabilities?

These are the liabilities the obligations of which depend on the occurrence and non occurrence of one or more future events. Means, the liabilities are yet to be finalized. It is waiting for some future events to be happened.

Suppose, a decision of a court case is about to come, if the decision is your against, you are going to pay some amount as penalty. Perhaps, the decision can be of your favor; you are not sure about it. This is the situation of your contingent liability; the occurrence of your liability depends upon the decision of judge. So till the decision come, you have to recognize it as contingent liability in your books of accounts.

Remember! The word “contingent” means “unpredictable” therefore, the liabilities which we cannot predict whether it is going to be actualized or not. If we can predict, it is no more a contingent liability it will be regarded as a pure liability.

Similarly, Banks give guarantee on the behalf of its customers. So if the customer fails to pay the amount, the bank has to pay. Here banks cannot recognize it as liability as it is not confirmed that customers will not pay the amount so it is a contingent liability for banks because it depends on the future activities of the customers. Banks has to show this contingent liability in the foot notes of its annual report at the end of its accounting year. In the next year, if customers pay all their dues, the bank gets free from its contingent liability but if they fail to pay, bank has to recognize it as liability in the year it is cleared that customer is insolvent.

This was about company, now take it practically. Suppose, your dad promised you to buy an I-phone for you if you get 1^st rank in your upcoming examination.  Now from your father’s point of view, the obligation to give you I-phone depends on your getting 1^st rank in exam. The liability of your father arises only if you got 1^st rank. If you do not get it, there will be no liability so until the results come out it’s a contingent liability for your dad.

It is very important point to be seen carefully in annual report at the time of analyzing a company by investor because this is the point where all the books are cooks by the management of the company.

Last, liabilities are recorded in the balance sheet but contingent liabilities are recorded in the footnotes of the annual report.

Hope now you have understood this concept very well. If any questions regarding this topic, write me in comment box below.