A contingency is an event or condition that may or may not happen, so that some other outcome depends on how it turns out. In accounting the word is narrower, and a standard defines it: a contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur (FASB Statement of Financial Accounting Standards No. 5, paragraph 1).
The condition has to exist already. What is unsettled is the resolution, and resolving it may confirm the acquisition of an asset or the reduction of a liability, or the loss or impairment of an asset or the incurrence of a liability (the same statement, paragraph 1).
An exposure the business has not yet suffered a loss on can still be a contingency. Where an enterprise is not insured against risk of future loss or damage to its property by fire, explosion, or other hazards, the absence of that insurance constitutes an existing condition involving uncertainty about the amount and timing of any losses that may occur, in which case a contingency exists (the same statement, paragraph 27). It is not an accruable loss, because the absence of insurance does not mean that an asset has been impaired or a liability has been incurred at the date of the financial statements (the same statement, paragraph 28).
That Statement is no longer authoritative on its own. On the effective date of Statement No. 168 all then-existing non-SEC accounting and reporting standards were superseded, with a short list of named Statements excepted until each was integrated into the Codification (FASB Statement of Financial Accounting Standards No. 168, paragraph 15), and that Statement establishes the Codification as the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities (the same statement, paragraph 6). The reorganization was not meant to change the guidance it gathered up, since the Codification’s purpose is not to create new accounting and reporting guidance (the same statement, paragraph A8). The loss contingency guidance sits in the Codification today at Subtopic 450-20 (FASB Accounting Standards Update 2016-13, paragraph 450-20-15-2).
Loss Contingencies and Gain Contingencies Are Not Symmetrical
The definition runs in both directions and the accounting does not. A loss contingency is accrued when it is probable and the amount can be reasonably estimated, disclosed when the chance is at least reasonably possible, and, guarantees aside, left alone when the chance is remote. Certain loss contingencies are disclosed even though the possibility of loss may be remote, and the common characteristic of those is a guarantee (FASB Statement of Financial Accounting Standards No. 5, paragraph 12). Those tests, and the paragraphs behind each of them, are set out in accruals.
A gain contingency does not climb that ladder. The Board has not reconsidered Accounting Research Bulletin No. 50 with respect to gain contingencies, so the provisions of paragraphs 3 and 5 of that Bulletin continue in effect: contingencies that might result in gains usually are not reflected in the accounts since to do so might be to recognize revenue prior to its realization, and adequate disclosure shall be made of contingencies that might result in gains, but care shall be exercised to avoid misleading implications as to the likelihood of realization (FASB Statement of Financial Accounting Standards No. 5, paragraph 17).
So a claim your client is pursuing usually stays out of the accounts even where the same claim, seen from the other side, would be accrued. The rule turns on realization rather than on the odds, so the work a strong claim creates is footnote work rather than an entry.
Where the Word Lands on a Filed Balance Sheet
Regulation S-X gives contingencies a line of their own. On the balance sheet a commercial or industrial company files, commitments and contingent liabilities is caption 25, and unlike the captions on either side of it, that line carries no instructions telling the filer what to state separately (17 CFR 210.5-02). What ends up there is decided by the recognition and disclosure guidance, so the caption tells a preparer where the item goes, not whether it belongs there. Where it falls inside the noncurrent block is set out in long-term liabilities.
Other article balance sheets number the same caption differently. An insurance company files it as caption 19 (17 CFR 210.7-03), and a bank holding company files it as caption 17 (17 CFR 210.9-03).
What a Contingency Is Not
A contingent liability is not a third class of liability, because absent a present obligation an uncertain future event does not by itself create one, which liabilities works through.
An uncertain income tax position sits outside this guidance and answers to the income tax standard instead.
An estimate on its own is not a contingency either, because where the obligation has already been incurred and only the amount is uncertain the item is an ordinary accrual, and accruals draws that line.
Common Questions
An event that might happen and might not, with an outcome that hangs on it. The accounting sense narrows that: the situation has to exist at the reporting date, so only its resolution is in the future, which is what separates a contingency from a plan for something that might come up.
In the plural the word usually names the whole set of uncertain gains and losses a business is carrying at the reporting date. Outside the accounts it names other things. A contingency in a purchase contract is a condition that has to be satisfied before the deal closes, a contingency fee depends on the outcome of the matter, and a contingency in a budget is money held back for what has not been specified yet. None of those is the accounting sense.
In ordinary use, eventuality and possibility come close, and contingency plan is the phrase most people are reaching for. In accounting there is no clean synonym, because the term is defined by the standard rather than by usage, and the nearest substitutes name only one direction of it, loss contingency or gain contingency.
Pending or threatened litigation is one of the standard’s own examples (FASB Statement of Financial Accounting Standards No. 5, paragraph 4). A warranty on a product already sold is another. A warranty is an obligation incurred in connection with the sale of goods or services that may require further performance by the seller after the sale has taken place, and because of the uncertainty surrounding claims that may be made under warranties, warranty obligations fall within the definition of a contingency (the same statement, paragraph 24).
One item on that list has since moved. Collectibility of receivables sits on it (the same statement, paragraph 4), and the measurement of credit losses for instruments within the scope of Topic 326 is now excluded from the loss contingencies subtopic (FASB Accounting Standards Update 2016-13, paragraph 450-20-15-2). A doubtful account is still an uncertainty, and it is now measured under the credit loss guidance that allowance for doubtful accounts covers.
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