Contingent liabilities are potential liabilities that a company may incur that are dependent on the outcome of future events in terms of whether or not they become actual liabilities. Contingent liabilities are distinguished from fixed liabilities, such as required loan or tax payments, that are reflected in a company's balance sheet and other financial statements. Among the most commonly recognized contingent liabilities are those arising from pending or possible future lawsuits, fines or penalties from government regulatory agencies, and possible tax penalties.

The most common lawsuits that a company might face are suits filed by individuals, class action lawsuits, and patent infringement or copyright infringement lawsuits filed by other companies. Examples of these are various class action suits that have been filed over the years against pharmaceutical companies, tobacco companies and automotive manufacturers. Patent or copyright infringement suits commonly occur between manufacturing firms, but they may arise in virtually any industry. Energy companies, such as oil and gas companies or coal companies, have often been the target of substantial fines from regulatory agencies such as the Environmental Protection Agency (EPA).

Other possible sources of contingent liabilities are more remote and include issues that can range from technological advancements to operations issues in foreign countries. For example, if a major technological advancement in manufacturing equipment or potential new government operational requirements suggest that a company may have to make substantial, unexpected capital expenditures to either upgrade or replace equipment, that represents a contingent liability. Political instability in a foreign country that potentially threatens major investments that a company has in that country can also present a contingent liability.

Because of the nature of contingent liabilities, the fact that the amount of liability, if any, is unknown while the liabilities remain contingent, companies do not ordinarily include them in their calculations of current liabilities on their balance sheets. The common practice is to outline contingent liabilities in the notes or footnotes appended to the balance sheet and other financial statements, such as the company's annual report.

Companies are required by law to include a contingent liability with the other liabilities on the company's financial statements if the contingent liability is a qualifying contingent liability. A qualifying contingent liability has a definite estimable value and more than a 50% probability of actually being incurred. However, very few contingent liabilities meet both of the requirements for classification as qualifying contingent liabilities.

There is disagreement between market analysts as to whether – or to what extent – contingent liabilities have a negative impact on a company's stock price. The most commonly held view is that significant contingent liabilities have some depressive effect that factors into a company's stock price. The extent of the impact is likely to be determined by how substantial the potential liability is, and the market's estimate of the likelihood of the contingent liability becoming a reality.

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  5. What are some examples of current liabilities?

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