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Let's talk about contingent liabilities. Contingent means it's based on something else. So this means it may or may not happen. It is contingent on something. So typically, when we're talking about liabilities, we're talking about something like payables, where you know you're gonna have to pay it. But a contingent liability means there's some event that you don't know the outcome of yet that will determine whether or not you have to pay it. This is typically stuff like lawsuits, warranties, that kind of thing. A lawsuit, you don't know which way it's gonna go. A warranty, you don't know how many units are gonna break down. And so we end up with these three different categories.
We end up with probable, possible, and remote. Now, you can tell these aren't super specific. This is one of the more gray areas of accounting. What differentiates probable versus possible? Fortunately for you, you don't have to know. It'll tell you it's probable, it's possible, or it's remote. Now, there's only one scenario in which you have to actually record a contingent liability, and that is if it's probable and can be estimated, and we're talking about estimated in dollars. If it can be estimated in dollars and it's probably gonna happen, then you have to record.
Now, if it is probable but can't be estimated in dollars, then you just have to disclose it. You just have to tell on your financial statements, "Hey, there's probably gonna be this payout. We have this probable liability. We have no way of estimating it, so I'm just gonna tell you about it." If it's possible, then you just have to disclose. And if it's remote, you don't have to do a dang thing because there are always lawsuits going on, and lots of them are never gonna go anywhere. So it's remote that most of those lawsuits are gonna come out where the company has to actually pay, and so it would be too burdensome to have to disclose everything that's remote, so we just don't do anything.
This is the one that's important, the ones that are probable and you can estimate relatively well what the dollar amount of those are gonna be. And so let's look at warranties as an example of one that can be estimated pretty well. I'm just gonna do a simple example. Let's say a company sells a product for $10,000, and based on management's experience of selling this $10,000 product, we know that about 5% of this $10,000 is going to have to go towards repairs, towards warranty expenses. So on average, for every $10,000 unit we sell, we spend $500 fixing it.
Now, we may spend $2,000 fixing one and zero fixing three others, but on average, we're spending $500 per unit. So what we do when we see this problem, and this is an example of a warranty problem or sometimes a guarantee problem, where basically we sell something, and we have to fix it within a certain time period. So because we know based on past experience that we're looking at a 5% expense here, what we do is we just say warranty expense of $500, and then we put it into this estimated liability account, super generic name, estimated liability at $500.
Okay. So I'm gonna draw a picture for you and see if this reminds you of anything else. So we're putting warranty expenses into this estimated liability, and then at some point, we're gonna take them out, right? Does this look like bad debts? We're putting something into this bucket because it's contingent, right? So with bad debts, we said, "I know some percentage of my accounts are gonna go bad, but I don't know when or for how much, so I'm gonna put 'em into this allowance account. And then when the time comes where something actually goes bad, I take it out of my allowance account." So if we say that sometime after this happens, the customer needs a $200 repair, well, we've already recognized the expense.
We don't recognize the expense again because that would be double recognition. We recognized it up front when we said, "I'm pretty good at estimating, so I'm gonna go ahead and estimate my $500." So what we do is it's no longer an estimated liability. So if a customer requires a $200 repair, we go ahead and take it out of this estimated bucket. And whatever it is that you used to repair, so let's say that we got a $200 part, some sort of supply for them, you would decrease your supplies. So the expense recognition happens upon the estimation, not upon the actual repair.
We're storing up future repairs in this estimated liability bucket. Then when the time comes, we say, "Hmm, that's too bad, but a long time ago, I estimated that that was gonna happen. I allowed for that situation. So now let me decrease my estimate and go ahead and just decrease my supplies too."