Contingent liability

If a firm has received goods from a supplier, along with an invoice that remains unpaid when the balance sheet is drawn up at, say, 31 December, the amount outstanding is recorded as a straightforward liability in the balance sheet – the debt is a known amount that must be paid. Trickier is what to do about legal action started by, say, an unhappy client.

Although there may still be a liability for the firm to settle, it is contingent on the outcome of the case, as is the amount of any payment. But investors still need to know about it. So firms usually leave any related liability out of the balance sheet, but describe the problem in a written contingent liabilities note towards the back of the financial statements.