What is a contingent liability?

A contingent liability is accurately defined as a liability that might arise from future events, which means it is uncertain and dependent on the outcome of those events. It refers to potential obligations that are not yet realized but could become actual liabilities based on the occurrence (or non-occurrence) of specific events.

For instance, if a company is facing a lawsuit and there is a possibility that it could lose the case, it would recognize this as a contingent liability on its financial statements if the loss is probable and the amount can be reasonably estimated. This helps users of the financial statements understand potential future impacts on the company’s financial position.

The other options do not align with this definition. An obligation that is guaranteed refers to certain liabilities, which are already recognized and do not involve uncertainty. An expense incurred from legal settlements pertains to actual costs already incurred rather than potential future costs. Finally, a debt that is currently due is a specific liability that is definite and requires payment at the present time, again lacking the uncertainty that defines contingent liabilities.