How Contingent Liabilities Are Disclosed on the Balance Sheet

Graziano Stefanelli
Oct 1
2 min read

Contingent liabilities represent potential obligations that may arise from past events but whose existence will be confirmed only by uncertain future events outside the company’s control. Because these obligations are not yet certain, they are not recorded as liabilities on the balance sheet unless specific recognition criteria are met. Instead, they are disclosed in the notes to the financial statements. Proper disclosure of contingent liabilities ensures that stakeholders are aware of risks that could affect the company’s financial position.

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When contingent liabilities are recognized or disclosed

Under IFRS (IAS 37: Provisions, Contingent Liabilities and Contingent Assets) and US GAAP (ASC 450: Contingencies), treatment depends on likelihood and measurability:

Probable and measurable: Recognize as a liability on the balance sheet and record an expense.
Possible but not probable: Disclose in the notes, but do not recognize on the balance sheet.
Remote: Neither recognized nor disclosed, unless material in rare circumstances.

For example, if a company is facing litigation with a probable loss of 200,000 and the amount can be reliably estimated, it must recognize a provision. If the outcome is possible but not probable, it is disclosed only in the notes.

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How contingent liabilities are presented in financial statements

Recognized provisions are recorded as liabilities on the balance sheet and reduce net income through an expense entry. Contingent liabilities that do not meet recognition criteria are disclosed in the notes, describing the nature of the contingency, its potential financial effect, and uncertainties involved.

Example disclosure might state:“The company is a defendant in several legal proceedings. While the ultimate outcome cannot be predicted, management believes that potential losses, if any, will not have a material effect on the financial position.”

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Journal entries when provisions are recognized

If a lawsuit settlement is probable and estimated at 200,000:

Debit: Legal Expense 200,000
Credit: Provision for Lawsuit (Liability) 200,000

If later paid:

Debit: Provision for Lawsuit 200,000
Credit: Cash 200,000

This ensures that expenses are matched to the period in which the obligation arose, not when the cash is paid.

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Key differences between IFRS and US GAAP

IFRS: “Probable” is interpreted as more likely than not (>50 percent). Provisions are measured at the best estimate, often using expected value techniques.
US GAAP: “Probable” is a higher threshold, requiring a higher degree of likelihood. If a range of loss is estimated, the minimum within the range is accrued, unless another point is the best estimate.

These differences can lead to earlier recognition under IFRS compared to US GAAP.

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Disclosures required for contingent liabilities

Both frameworks require disclosures of:

Nature of the contingency.
Estimate of financial effect or statement that it cannot be estimated.
Uncertainties about timing or outcome.
Possibility of reimbursement (e.g., insurance coverage).

Such disclosures give investors visibility into risks that may not yet appear on the balance sheet but could affect future financial results.

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Operational considerations

Contingent liabilities are critical in sectors such as pharmaceuticals, construction, energy, and banking, where lawsuits, guarantees, and regulatory issues are common. Transparent disclosure reduces the risk of surprises for investors and enhances trust in management’s reporting. Failure to properly disclose contingent liabilities can lead to reputational damage and regulatory penalties.

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DATA STUDIOS

.....[datastudios.org]