In this case, the company needs to account for contingent liability by making proper journal entry if the potential future cost is probable (i.e. likely to occur) and its amount can be reasonably estimated. GAAP accounting rules require that probable contingent liabilities that can be estimated and are likely to occur be recorded in financial statements. Contingent liabilities that are likely to occur but can’t be estimated should be included in a financial statement’s footnotes.

What Is the Journal Entry for Contingent Liabilities?

If the boot is on the other foot and you’re suing someone else for damages, it doesn’t go on the books until you actually collect. You can mention the lawsuit in notes to the financial statements, but you can’t include it as income or an account receivable, even if you think winning damages is a slam-dunk. Accounting standards favor a conservative approach to potential contingent gains. When you finally have the cash in hand, then you report it as income. The liability should not be reflected on the balance sheet if the contingent loss is remote and has less than a 50% chance of occurring. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.

Contingent Liability Journal Entry

You can estimate company expenses and income for the next quarter, but you can’t say for certain someone won’t up and sue you. When you pay legal damages or receive them, you report the result as income or loss on the income statement. journal entry for lawsuit settlement From a journal entry perspective, restatement of a previously reported income statement balance is accomplished by adjusting retained earnings. Revenues and expenses (as well as gains, losses, and any dividend paid figures) are closed into retained earnings at the end of each year.

This entry adjusts the accrued liability to reflect the updated estimate of the loss. The $600 most likely outcome was not used because the other estimates were all lower; instead, an expected value was used as a better estimate of the expected outcome. Again, I recommend working with your own CPA on this, before you make a bit of a mess in the accounting for something you want to Document, that is not Actual, at this time. And doing JE bypasses Cash Vs Accrual Basis reporting, so that is the Worst thing to do, for “I want Other Asset offset as $200k income, even though no money happened.”

The company should report a contingent liability equal to probable damages if a court is likely to rule in favor of the plaintiff either because there’s strong evidence of wrongdoing or some other contributing factor. The issue really is I run the business on accrual, which in my opinion is how any business should be run. When the business was revenue 2M and many employees it was imperative that I run it that way. The company is now very much smaller so it might simply not be necessary to run it on accrual anymore in which case I can just know that’s out there and not worry about the balance sheet. IFRS also requires risks that are specific to the liability to be reflected in the best estimate.

1. These guidelines apply to any contingent liability, such as an IRS auditor having to pay out for a warranty.
2. Certain legal claims may be subject to reimbursement, in the form of insurance proceeds, indemnities or reimbursement rights, such as in these examples.
3. “Sell” the settlement on an Invoice as other income for $200,000.
4. Company A is involved in a lawsuit, and after consulting with legal counsel, they determine that it is probable they will lose the case.
5. Contingent Liability is the potential loss dependent on some adverse event.

If you are trying to show someone is in debt to you, but you did not Pay Out any money or sell them a fixed Asset, you really do not want to see the full balance owed to you as Income, already. That is Law Contract Settlement activity; not your actual financial entry. Let’s see some simple examples of the contingent liability journal entry to understand it better.

This “a journal entry for the 200,000  crediting other income” is why. The lawsuit was considered a contingent liability in the books of Samsung ltd, with an estimated value of $700 million. However, full disclosure should be made in the footnotes of the financial statements. For dual preparers, differences in the IFRS and US GAAP requirements related to recognition and measurement may result in different liability amounts.

Contingent liability journal entry

These guidelines apply to any contingent liability, such as an IRS auditor having to pay out for a warranty. Working through the vagaries of contingent accounting is sometimes challenging and inexact. Company management should consult experts or research prior accounting cases before making determinations. The company must be able to explain and defend its contingent accounting decisions in the event of an audit. “The thing I’ve learned here is that journal entries don’t respect cash vs accrual which is disturbing because it would be easy and obvious but that’s the way it is so I have to live with that.” Now those are the mechanics of it, I want you to review the process with your tax CPA to ensure that you can defer the income as payments are received.

Just because you and I can agree that it should be so does not always mean the IRS will agree. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. The $600 outcome has a 75% probability, 15% for $500 and 10% for $400.