Contingency is an undefined future event or condition that, if it occurs, could have a material impact on a company’s financial condition, operating performance, or cash flows. For example, a company may be involved in a lawsuit that could have a negative outcome, or it may be relying on a new product launch to drive growth. What is an example of a contingency? A contingency is an event or condition that may or may not occur in the future, and which would have an impact on the financial statements of a company if it did occur. For example, a company may have a contingency plan in place in case one of its key suppliers goes out of business. This contingency plan would likely involve the company sourcing its supplies from other suppliers, which would incur additional costs. What is contingency in finance? In finance, contingency refers to a situation where the outcome of a decision depends on future events that are uncertain. For example, a company may decide to invest in a new product line only if sales of the product exceed a certain level. This is a contingency because the company cannot be certain that sales will reach the required level.
There are two types of contingency:
1. Event-contingent: The occurrence of an event triggers a particular course of action. In the example above, the event is the product sales exceeding the certain level.
2. State-contingent: The future state of the world determines a particular course of action. For example, a company may decide to invest in a new product line only if the economy is in a recession. This is a state-contingent contingency because the company cannot be certain about the future state of the economy.
What are types of contingency?
There are several types of contingency that can occur in corporate finance, including financial, commercial, and legal contingencies. Financial contingencies typically arise from unexpected changes in the financial markets, such as a sudden drop in the stock market or a change in interest rates. Commercial contingencies can arise from changes in the business environment, such as a new competitor entering the market or a change in consumer spending habits. Legal contingencies can arise from changes in the legal landscape, such as a new regulation being enacted that affects the company's business. Why are contingency funds made? There are many reasons why companies set aside contingency funds. Some of the most common reasons include:
1. To cover unexpected costs: Unexpected costs can include anything from unanticipated repairs or maintenance to legal fees.
2. To cover unexpected revenue shortfalls: If a company experiences a drop in sales, it may need to dip into its contingency fund to make up for the lost revenue.
3. To cover unexpected expenses related to expansion or growth: A company that is expanding its operations may need to set aside funds to cover unexpected costs associated with the expansion.
4. To weather a temporary dip in business: A company that experiences a temporary dip in business may need to use its contingency fund to keep operations afloat until business picks back up.
5. To protect against risks: Some companies set aside contingency funds to protect themselves against risks such as natural disasters or economic downturns.
What is a contingent asset in accounting? A contingent asset is an asset that is not recognized in the balance sheet because it does not meet the recognition criteria. Contingent assets are not reported in the financial statements because they are not probable of resulting in future economic benefits.