Posted: November 22nd, 2015

Contingent Liabilities

First page to be written on:
Identify how contingent liabilities affect financial decisions.
A contingent liability is a potential liability whose realization depends upon the future outcome of an event.
Consider the features of contingent liabilities and respond to the following:
Explain how contingent liabilities impact financial decisions. Give examples.

The second page is a response to other students comments as follows below:

“Contingent liabilities aren’t considered to be actual liabilities. “A contingent liability is a potential liability that depends on the future outcome of past events (Harrison, Horngren, & Thomas, 2013, p 524).” Meaning that the loss is only possible and it may or may not become an actual loss and the uncertainly can only be resolved by the future occurrence. Contingent liabilities are recorded and displayed on financial statements as footnotes, when it is a probable liability that has been incurred, but has not been recorded as a liability on the balance sheet. A contingent liability may arise from lawsuits, tax disputes, and alleged violations of environmental protection laws that claim wrongdoing by the company events (Harrison, Horngren, & Thomas, 2013, p 525). Two examples of contingent liabilities include outstanding lawsuits and product warranties.

Contingent liabilities can impact financial decisions based on the relevance and reliability of the information featured in the financial statement. Contingent liability regulations require that lawsuits, tax liabilities and guaranteed liabilities be disclosed with the probability and possibility of any short comings. The main objective of information disclosure is to help and assist users/ investors of the information in making decision for investment and appraisal of the management performance quality (Darabi & Faghani, 2012). When contingent liabilities are avoided it misleads users of the financial statements and could leave them in a unexpected financial bond.

Outstanding lawsuits: A company may be facing a lawsuit from the government for alleged environmental violations. If the company is found guilty and loses the lawsuit they will have to pay an innumerous penalty to the government. Resulting in the company undergoing a huge loss and their share price being affected due to their reputation.

Product Warranty: A company sells 15,000 TV’s last year with a product warranty of one year. The company made an assumption that only 200 TV’s may defected and would use the coverage provided by the one year warranty. Instead of 200 defected TV’s needing and using the warranty 300 TV’s used the warranty. The company has reserves for only 200 TV’s and now has to make additional provisions to warranty all 300 defected TV’s. This incident will lead to a financial loss to the company.”