A contingent liability, defined is an obligation that a company might or might not have to recognize. This is because the event(s) are uncertain. It is also necessary for future events to occur to determine whether or not the obligation is true or not. Contingent liability exposure or the amount estimable may or may not be recognizable.
Furthermore, contingent liabilities can be anything ranging from litigation proceedings to accounts payable if a supplier did not provide a product or service to a company. Contingent liability recognition typically depends on two things, the likelihood of loss and the ability to estimate the loss. There are three descriptors to estimate the likelihood. These range from remote, to reasonably probable, to probable. Estimates are measured in two dimensions, which are reasonably estimable to not-reasonably estimable. Companies typically want to understand where they stand with a contingent liability, because the factors determine how a company should provide contingent liability disclosure in its financial statements.
For example, Blowout Preventer Inc. makes blowout preventers for drilling companies. Recently one of its products “malfunctioned” causing a massive explosion on a rig owned and operated by one of its primary customers Big Chief Inc. Big Chief has sued Blowout for the total sum of the rig as well as each worker’s salary. Big Chief has estimated this amount at an even $10 million dollars. Blowout Preventer’s lawyers have determined that it is probable that they will lose the case and have to pay the sum amount. Blowout Preventer must first accrue the $10 million on it’s books because the amount is reasonably estimable and also make a note on its financials. If the amount had not been reasonably estimable there would simply need to be a note in the financials discussing the case and probability that the company would need to pay some sort of monies.