Contingent Liabilities

A contingent liability is one which arises on the happening of an unfavorable event. There is no actual legal obligation on the date of balance sheet. It is therefore potential obligation usually dependent on a future event beyond the control of the business enterprise. As future events occur or fail to occur, this contingent liability may or may not become payable, as the case may be. Examples of contingent liabilities are:

(a) Contingent liability on bills discounted:

If a bills receivable is discounted with he bank or endorsed to a third party, there is a contingent liability to the bank or endorsee until the bill is paid by the acceptor on the third party, third is a contingent liability to the bank or endorsee until the bill is paid by the acceptor on the due date.

(b) Contingent liability as a surety for another person:

If A stands surety for B in respect of a payment of debt to C, this obligation is a contingent liability to the surety A until the payment is made by principal debtor B since A will be called upon to pay C if B defaults in the payment.

(c) Contingent liability in respect of pending suit:

A suit pending against the business enterprise is a contingent liability since the suit may be decided against it and therefore it may become liable to pay compensation. When a contingent liability becomes a real liability on the happening of an event, it will either result in a loss or it will give an asset of equal amount in exchange. For example, when a bill of exchange endorsed or discounted is dishonored by the acceptor, the business enterprise will have to pay the amount to the endorsee or the bank as the case may be. It becomes an actual liability on it. But after the money has been paid on behalf of the acceptor, he (the acceptor) becomes debtor of the firm for the payment of liability. However, if the acceptor does not own any property the contingent liability will result in a loss to the business. A contingent liability must be distinguished from an estimated or disputed liability; the latter is a definite obligation but the amount is uncertain at the balance sheet date. There may not be any doubts as to the amount of a contingent liability e.g., a court case, but there is considerable uncertainty as to whether the obligation will actually materialize.

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