What is contingent liability?
Contingent liability, sometimes referred to as indirect liability, is a responsibility that occurs based on the outcome of a particular event that provides coverage for losses to a third party for which the insured is vicariously liable. Depending on the way that event unfolds, financial obligations might arise in which the company that holds the liability would be accountable to see it through. If the contingency is probable with a reasonably estimated amount, it is recorded in a financial statement. If both of those conditions cannot be met, the contingent liability could be inserted in the footnote of a financial statement. Some common examples of contingent liabilities are product warranties and pending lawsuits because they both have uncertain end results, but still pose a potential threat.
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When do I need to be aware of contingent liability?
When a company becomes involved in a lawsuit, it’s time to understand more about contingent liability. The company’s lawyer might feel the other party’s case is fairly strong, which is a situation that’s going to lead to damages. The company would then post an entry on their accounting budget to increase legal expenses. If the company loses the lawsuit, the cash is reduced. Situations involving contingent liability often arise when companies work with contractors, subcontractors, or agents, where both the company owner and the party primarily responsible for the injury or damage can be held liable. Contingent liability insurance plans—including occupational insurance and occupational accident insurance that protect individuals like independent contractors who are not traditionally covered by workers’ compensation insurance—can help companies minimize their risk exposures.
What is important to know about contingent liability?
There are always special considerations when dealing with financial issues such as contingent liability. By understanding the following concepts, business owners and their legal teams are ready when the business needs protection:
- When a liability is disclosed in footnotes, the firm can determine whether the likelihood of occurrence is more remote than probable, and if so, does not have to disclose the potential of it.
- The reason contingent liabilities are recorded is to meet IFRS and GAAP requirements and so the company’s financial statements are correct.
- Even when a company and their legal team doesn’t know an exact amount, there is an estimate listed in the account because estimated liabilities are almost certain to happen.
- Part of the reason contingent liabilities must be included in financial statements is to give the readers of the statement accurate information.