Companies cannot do business without taking liabilities and such liabilities may come from the owner in the form of capital or may come from outsiders in the form of secured or unsecured loans but there is another liability which is different from all other liabilities and that is called contingent liabilities, majority of people get confused between the contingent liabilities and other liabilities and if you are one of those people who is confused between the two terms then you should know the difference between contingent liabilities and liabilities
Contingent Liabilities Vs Liabilities
Meaning
Contingent liability in simple words refers to those liabilities which may or may not arise as this liability is dependent on happening or non-happening of an event in future and well know that future events cannot be predicted by anyone whereas other liabilities refers to those liabilities which have already incurred or happened and the company has to make payment for such liabilities in the near future.
Example
Bank guarantee, claims not acknowledged as debts, court litigations going against the company are some of the examples of contingent liability while bank loan, the loan from finance companies, unsecured loans, creditors are some of the examples of liabilities which happen in the normal course of the business of the company.
Treatment in Balance Sheet
Contingent liability is not shown anywhere in the balance sheet rather it is disclosed merely as a footnote to the balance sheet whereas as far as other liabilities are concerned they are shown in the balance sheet under different heads like secured, unsecured loan and liability which have to be paid within a year are shown under current liabilities and so on. In simple words, while other liabilities are recognized in the balance sheet of the company but contingent liabilities are not recognized in the balance sheet of the company.
Certainty about Outflow of Funds
In case of contingent liability, there is no certainty that company has to pay to other parties as contingent liability may or may not happen but as far as other liabilities are concerned there is certainty that those liabilities will have to be paid by the company.
Planned and Unplanned
In case of other liabilities company can plan in advance about the repayment schedule and make provision accordingly, hence for example liabilities like bank loan repayment installment or payment to sundry creditors are done on fixed date and hence the company can arrange the funds accordingly but as far as contingent liability is concerned companies cannot determine the quantum, as well as timing of occurrence of liability and hence companies, cannot make any concrete plan about contingent liabilities.
As one can see from the above that there are many differences between the two terms and while analyzing the balance sheet as well as profit and loss statement one should keep in mind the above differences as sometimes contingent liability can turn out to be actual liability and if the amount is huge than it can put a big dent on the profits as well as the financial position of the company.