Answer:
Contingent liabilities refer to those obligations which might arise in the near future based upon the happening or non happening of a certain event and it's outcome.
Such liabilities are recorded if there is likeliness of an event happening and when they can be reasonably quantified and estimated.
In the given case, the automobile manufacturer will probably be required to recall it's products. The amount can be estimated.
In such cases, such expense is to be recognized in the income statement and at the same time a liability for such expenses needs to be created in the balance sheet. Product recall refers to replacement of defective products by the manufacturer. It is similar to a warranty.
Reporting on Dec 31 would be as follows,
Warranty Expense A/C Dr. $2.5
To Warranty Liability $2.5
(being product recall liability for for 2.5 million created)
