Contingent liabilities

What it means

Contingent liabilities are possible obligations of a company whose existence depends on an uncertain future event not wholly within its control. Typical examples are a guarantee of another company’s loan, an issued bank guarantee, a pending lawsuit or bills of exchange the company has endorsed.

Contingent liabilities are not recognised on the balance sheet, because it is not certain whether they will arise at all or in what amount. They are, however, disclosed in the notes to the financial statements so that readers know about risks the figures do not show.

If the probability changes and an outflow becomes probable and can be reliably estimated, the contingent liability turns into a provision, which is charged to expenses and appears on the balance sheet. If the obligation is certain, it is an ordinary liability.

How it works in practice

Before the financial statements we ask clients about guarantees, sureties, disputes and other agreements that have not shown up in the books. Owners have often signed them personally or in another company, and there is no trace of them in the accounting documents.

For lawsuits we assess with the lawyer how likely a loss is and for how much. If a loss is probable we create a provision; otherwise we describe the dispute in the notes. We treat unfinished tax audits the same way.

Where the company guarantees group loans, we monitor the debtor’s financial position. When it deteriorates, we reconsider whether a provision is now needed and inform management, because banks may react to this too in relation to the company’s own loans.

What to watch out for

An undisclosed contingent liability distorts the picture of the company. When a business is sold or an investor comes in, it will surface in due diligence and may lead to a lower price or claims for damages against the seller.

An event after the reporting date, such as losing a lawsuit, may require the statements to be adjusted if it confirms a condition that already existed at the reporting date. We assess this under the rules on events after the reporting period.