CONTIGENT LIABILITY

DEFINITION

A contingent liability is a potential liability that may or may not occur, depending on the result of an uncertain future event. The relevance of a contingent liability depends on the probability of the contingency becoming an actual liability, its timing and the accuracy with which the amount associated with it can be estimated.

WHY PROVISION

• Nature is uncertain
• Future Expenses
• Help to assess and prepare for the situation

TYPE

• Probable: Probable means future events are likely to occur. One can reasonably estimate the amount. Eg;- 
• Possible: Chance of occurrence reasonably possible to estimate and not probable. 
• Remote:  Liability not recorded or disclosed. Liability is not likely to occur and is not reasonably possible.

EXAMPLES

• Guarantee is given by the company for product
• A third-party guarantee is given on loan
• Letter of credit issued
• Potential adverse judgment on cased regarding a financial dispute

JOURNAL ENTRY

Provision

Lawsuit A/c                                Dr.            100

Lawsuit liability A/c                     Cr.                             100

(Lawsuit provision booked)

Lawsuit Liability A/c                     Dr.                100 

Cash                                           Cr.                                100

(Lawsuit Liability paid)