While the borrower keeps payingNothing is owed
The moment they stopThe whole guaranteed amount can be owed
Net Worth & Solvency Glossary · Net Worth Mechanics
Contingent Liability: What It Means for a Net Worth Certificate
noun · plural "contingent liabilities" · a possible obligation; disclosed on a certificate, not deducted
Definition
A contingent liability is a possible obligation that will become payable only if a future event happens, an event that is outside the person's control and may never happen.
Common examples are a guarantee given for someone else's loan, a tax demand under appeal and a lawsuit where liability is denied. A net worth certificate discloses contingent liabilities beside the figure. It does not deduct them from it.
Where it sits on the statement
Assets owned
less Liabilities owed
Net worth
Contingent liabilities disclosed, not deducted
- Guarantee given for another person's loan
- Tax demand under appeal
- Suit pending, liability denied
Amount at stakeCurrent stage
The trigger
01When a possible obligation becomes a contingent liability
Nothing is owed today. The whole amount can be owed the moment one event happens.
While the appeal is openNothing is owed
If the appeal failsThe demand falls due
While the case is pendingNothing is owed
If the court finds againstThe claim becomes payable
A personal guarantee for a relative's business loan is the clearest case. Nothing is owed while the borrower keeps paying, and the whole guaranteed amount can be owed the moment they stop. A disputed tax demand under appeal works the same way, and so does a pending suit for damages where liability is denied.
What makes an item contingent is that the outcome depends on an uncertain event outside the person's control.
Certain in amount and timing
Simply a liability. It is deducted like any other.
Depends on an uncertain event outside the person's control
A contingent liability. It is disclosed, not deducted.
How is it different from a provision?
Provision
A liability that is probable and can be reliably estimated, so it is recorded in the accounts.
Contingent liability
Not recorded, because the outflow is not probable or cannot be measured, so it is disclosed instead.
Disclosed, not deducted
02Why contingent items are disclosed below the net worth figure instead of deducted
Deducting a contingent item would misstate the position as badly as ignoring it.
Deducting it
Taking off the full amount of a guarantee that will probably never be called understates what the person is worth, sometimes dramatically.
Omitting it
Leaving it out hides a risk that a lender, tender committee or court is entitled to weigh.
Disclosing it below the figure
Gives the reader both the net worth and the exposure, and lets them decide how seriously to take it. That judgement belongs to the reader, not to the accountant.
A net worth certificate signed by a CA therefore shows contingent liabilities in a separate note, with the amount at stake and the current stage of each.
Is a contingent liability a current liability?
No. It is not a liability on the balance sheet at all until the event happens and the obligation becomes probable. At that point it becomes a provision or a liability, and is classified as current or non-current like any other.
Asked by name
03Personal guarantees, disputed tax demands and pending suits Indian CAs ask about
A CA asks about each of these by name, because clients reliably forget them.
- 1Personal guarantees
Signed years ago for a company or a relative's loan. They have cost nothing so far, so they stop feeling like obligations.
- 2Co-borrower or co-applicant positions
On someone else's loan.
- 3Disputed income-tax or GST demands
Under appeal, especially long-running ones.
- 4Pending civil suits
With a money claim.
- 5Letters of comfort
Given to a subsidiary's bankers.
- 6Bills discounted with recourse
And undertakings given to landlords or others.
Why each is asked about specifically. A general question about "other liabilities" gets a general answer. The written representation the client signs at the end of the engagement names these items for the same reason.
Written by Subham Jhunjhunwala · Reviewed by CA Sundram Gupta
This entry describes Indian practice in general terms.
Need help with a certificate that uses contingent liability? See our Net Worth Certificate.