Definition and Analysis of Contingent Liabilities

• Contingencies are potential gains and losses whose settlement depends on one
or more future events. A loss contingency is a potential claim on company
resources and is known as a contingent liability. liabilities and losses are
recorded in the financial statements.
• Our analysis of these liabilities is only as accurate as estimates determined by
the company based on previous experience or future expectations. Disclosure
of records for contingencies typically includes:
1. Description of contingent liabilities and risk levels.
2. The magnitude of the potential contingency and how the participation of
others is treated in determining risk exposure.
3. Expenses, if any, to revenue for contingent loss estimates.
• Example :
Contingent liability involves frequent flyer mileage. Unredeemed
frequent flyer mileage entitles airline passengers to billions of miles of
free travel. Frequent flyer programs ensure customer loyalty and offer
marketing benefits that are not cost-free. Because realization of these
liabilities is probable and can be estimated, they must be recognized on
the balance sheet and in the income statement.
Commitment Definition and Example
• Commitment is a potential claim to a firm's resources due to future
performance under the contract. They are not recognized in the financial
statements because events such as signing a executing contract or issuing a
purchase order are not completed transactions. A lease agreement is in most
cases a form of commitment.
• Example :
The company signed a patent licensing agreement with a former major
supplier of handheld laser scanning devices. This agreement stipulates that
the Company may manufacture and sell certain laser scanning products of its
own design and that the Company pays minimum royalties and purchases
other products in minimum quantities from such suppliers.