Contingent Liabilities

Alchemist · #1 4th December 2009, 08:24 AM

Contingent Liabilities are possible future liabilities that will only become certain on the occurrence of some future event.

e.g.

- pending litigations against a company.
- excise claims etc.
- product warranties.

Contingent liabilities which are probable (likely to occur) and for which the amount of loss can be reasonably estimated, are provided for in the accounting statements.

Other contingent liabilities are either mentioned in the notes to the accounts or not disclosed.

(Contingencies may also be in the form of contingent gains, but in preparation of accounts, contingent gains are not recorded until they are actually realized. At most, gain contingencies are mentioned in the notes to the accounts).

Prudent_Investor · #2 4th December 2009, 07:09 PM

So does this have a direct impact on the book value ?

Alchemist · #3 4th December 2009, 09:31 PM

Quote:

Originally Posted by Prudent_Investor

So does this have a direct impact on the book value ?

yes.

a contingent liability is like any other loss and reduces the book value of the company.

when a contingent liability is provided for, it is done by a charge in the P&L account.

if the contingent liability isn't provided for and becomes an actual loss, it still reduces the final profit of the company.

as profits are added to the net worth (book value) of the company, a reduction in profit means a reduction in net worth (book value).

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Main Principles - Accounting for Contingencies:

Quote:

10. The amount of a contingent loss should be provided for by a charge in the statement of profit and loss
if:
(a) it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and (b) a reasonable estimate of the amount of the resulting loss can be made.

11. The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of a loss is remote.

12. Contingent gains should not be recognised in the financial statements.

Source:

http://www.mca.gov.in/Ministry/notif...n/pdf/AS_4.pdf