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What are contingent liabilities?
Contingent liability is the liability which depends on future uncertain events of a company. In other words, this liability becomes potential liability depending on the future occurrence of events.
Reasons for contingent liability which are recorded based on accounting principles are as follows −
- Full disclosure principle − Reduction in company’s asset and net profitability which has negative impact on company’s financial performance.
- Materiality principle − It may influence decision making of different people, who use the company’s financial statements.
- Prudence principle − If the probability of occurrence of estimated contingent event is more than 50%, then the expenses are recorded.
The accounting treatment for contingent liability is as follows −
The examples of contingent liability are as follows −
- Warranty (products)
- Letter of credit issued
- Adverse judgment (if any)
- Differentiate between contingent liabilities and liabilities
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- Explain GAAP guidelines for contingent liabilities
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