If both conditions are met, a company must accrue the estimated loss and disclose the relevant information in the financial statements. With IAS 371, IFRS has one-stop guidance to account for provisions, contingent assets and contingent liabilities. In another case, if the future cost is remote (i.e. unlikely to occur), the company doesn’t need to make journal entry nor disclose contingent liability at all. Other the other hand, loss from lawsuit account is an expense that the company needs to recognize (debit) in the current accounting period as it is a result of the past event (i.e. lawsuit). If the contingent liability journal entry above is not recorded, the ABC’s total liabilities and expenses will be both understated by $25,000. The information is still of importance to decision makers because future cash payments will be required.
What costs to include?
You can use a JE to create the receivable asset but not against income. I know you want the remaining balance to show as an asset on the balance sheet .
How to Account for Potential Lawsuit Liability
Unfortunately, this official standard provides little specific detail about what constitutes a probable, reasonably possible, or remote loss. “Probable” is described in Statement Number Five as likely to occur and “remote” is a situation where the chance of occurrence is slight. “Reasonably possible” is defined in vague terms as existing when “the chance of the future event or events occurring is more than remote but less than likely” (paragraph 3). The professional judgment of the accountants and auditors is left to determine the exact placement of the likelihood of losses within these categories.
Contingent liability journal entry
- Entities often make commitments that are future obligations that do not yet qualify as liabilities that must be reported.
- Two classic examples of contingent liabilities include a company warranty and a lawsuit against the company.
- Let’s see some simple examples of the contingent liability journal entry to understand it better.
There is not yet a liability to report; no journal entry is appropriate. A business accounting journal is used to record all business transactions. Each business transaction is recorded using the double-entry accounting method with a credit entry to one account and a debit entry to another. Contingent liabilities are recorded as journal entries even though they’re not yet realized. Suppose a lawsuit is filed against a company and the plaintiff claims damages up to $250,000.
The liability must have more than a 50% chance of being realized if the value can be estimated. Qualifying contingent liabilities are recorded as an expense on the income statement and as a liability on the balance sheet. Contingent liability is a potential obligation that may or may not become an actual liability in the future.
When should a provision for a legal claim be recognized?
It’s impossible to know whether the company should report a contingent liability of $250,000 based solely on this information. The company should rely on precedent and legal counsel to ascertain the likelihood of damages. The debit to the legal expense represents the estimated loss due to the legal claim, while the credit to the legal claims payable represents the liability for the claim.
Two classic examples of contingent liabilities include a company warranty and a lawsuit against the company. Both represent possible losses and both depend on some uncertain future event. Contingent Liability is the potential loss dependent on some adverse journal entry for lawsuit settlement event. When such liability is likely and can be reasonably estimated, it is recorded as a loss or expense in the income statement. Any probable contingency must be reflected in the financial statements.