What is a contingent liability?

A contingent liability refers to a potential obligation that may arise based on the outcome of a future event. This means that the liability is not certain; rather, it is dependent upon something that has not yet happened, such as a lawsuit or a warranty claim.

In financial accounting, contingent liabilities are not recognized in the financial statements unless they are probable and can be reasonably estimated. Instead, they are disclosed in the notes to the financial statements to inform stakeholders of possible future obligations. This treatment ensures that financial statements reflect a company's actual financial position while also making users aware of potential risks.

The other choices do not accurately capture the nature of contingent liabilities. Immediate recognition (as in the first choice) applies to known liabilities, while a liability being settled without payment (the third choice) does not define a contingency. Lastly, stating that a liability can be ignored (the fourth choice) contradicts the importance of recognizing contingent liabilities in financial disclosures.