Contingent liability
AccountingA possible obligation disclosed in the notes rather than recognised, because an outflow is not probable or cannot be measured reliably.
Also written: contingent liabilities, contingency, disclosed contingency
IAS 37 sets a threshold. Where a present obligation exists, an outflow of resources is probable, and the amount can be estimated reliably, a provision is recognised and hits profit. Where any of those fails, the item is a contingent liability: described in the notes with an estimate of the financial effect where practicable, and absent from every total on the face of the statements.
The judgement sits on the word probable, which IFRS reads as more likely than not. That is a lower bar than US GAAP, where the equivalent standard requires a loss to be probable in a sense practice interprets as substantially higher, so the same lawsuit can produce a recognised provision under IFRS and a note under US GAAP.
This is a live issue in diligence rather than an accounting technicality. Environmental remediation, product liability, tax authority challenges and disputed earnouts all commonly appear as contingencies, and a buyer that treats the notes as boilerplate has priced a business without pricing the claims against it. Indemnities, escrow and warranty and indemnity insurance exist largely to allocate exactly these risks.
The mirror item, a contingent asset, is treated asymmetrically and deliberately so. It is disclosed only when an inflow is probable and recognised only when realisation is virtually certain, which reflects the general conservatism of the framework.
Worked example
A manufacturer faces a claim of 50. Counsel judges the outcome genuinely uncertain, so no outflow is probable and nothing is recognised. A note describes the claim.
Profit, net assets and every leverage ratio are unaffected, and the company may still write a cheque for 50. That gap between what the totals say and what the notes disclose is the reason the notes get read.