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Paper 1 Principles and Practices of Accounting Theoretical Framework 1.27
Table 1.4 Liability vs Contingent Liability
Liability Contingent Liability
Presents financial obligation of an enter- Outflow of resources to settle the obliga-
prise, which arises from past events. tion is not probable.
Settlement of a liability results in an (or)
outflow of economic resources.
The amount expected to be paid to settle
the liability cannot be measured reliably.
Example: Loan borrowed from third Example: Guarantees given on behalf of
parties which needs to be repaid, trade third parties, claims not acknowledged as
payables. debts, statutory bills under dispute.
(In all liablities there is a definitive obli- (The definite obligation (need to pay) has
gation (need to pay).) not arisen yet, but may arise in future.)
Table 1.5 Provision vs Contingent Liability
Provision Contingent Liability
Present liability of uncertain amount, which can Possible obligation which may
be measured reliably. or may not crystalise based on
uncertain future events.
It meets the recognition criteria. (They are rec- It does not meet the recognition
ognised in balance sheet as “Liability”.) criteria.
Recognition of provision - Present obligation Recognition of contingent lia-
arising out of past events resulting in probable bility – when the settlement of
outflow of economic resources and reliable esti- the obligation is not probable or
mate can be made. when reliable estimate of the
amount cannot be made.
Case study 1.2 Understanding Contingent Liability, Provision and Liability
A Ltd has given guarantee on behalf of B Ltd to the bank, i.e. A Ltd will pay the bank in
case of any default by B Ltd. On the date of issuing guarantee it was clear that there
will be no default made by B Ltd.
At this point of time, there is no probable outflow of economic resources for A Ltd.
Hence a contingent liability is created and disclosed in the notes to accounts of FS of
A Ltd.
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