The term ‘contingent liabilities’ refers to obligations relating to past transactions or other events or conditions that may arise in consequence of one or more future events which are presently deemed possible but not probable. Contingent liabilities may or may not crystallize into actual liabilities. If they do
become actual liabilities, they give rise to a loss or an expense. The uncertainty as to whether there will be any legal obligation differentiates a contingent liability from a liability that has crystallized. Contingent liabilities should also be distinguished from those contingencies which are likely to result in a loss (i.e., a loss is not merely possible but probable) and which, therefore, require an adjustment of relevant assets or liabilities. Some of the instances giving rise to contingent liabilities are:
- law suits, disputes and claims against the entity not acknowledged as debts.
- membership of a company limited by guarantee.
The following general procedures may be useful in verifying contingent liabilities.
- Review of minutes of the meetings of board of directors, committees of board of directors/other similar body.
- Review of contracts, agreements and arrangements.
- Review of list of pending legal cases, correspondence relating to taxes, duties, etc.
- Review of terms and conditions of grants and subsidies availed under various schemes.
- Review of records relating to contingent liabilities maintained by the entity.
- Enquiry of, and discussions with, the management and senior officials of the entity.
- Representations from the management.
The auditor should verify that contingent liabilities do not include any items which require an adjustment of relevant assets or liabilities.
