Accounting Standard 29 issued by the ICAI deals with the “Provisions, Contingent Liabilities and Contingent Assets”. According to it a contingent liability is
- a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the enterprise; or
- a present obligation that arises from past events but is not recognized because: it is not probable that an outflow of resource embodying economic benefits will be required to settle the obligation; or a reliable estimateof the amount of the obligation cannot be made. According to this statement, the contingent liabilities are not recognized because their existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future event not wholly within the control of the enterprise. In addition, the term “contingent liability is used for liabilities that do not meet the recognition criteria. As per above definition, to be called contingent liability the following condition must be fulfilled:
- possible obligation as a result of past event;
- existence of which will be confirmed only by the occurrence or non-occurrence of future event; and (c) future event not wholly within the control of the enterprise. An obligation is a possible obligation if based on the evidence available, its existence at the balance sheet date is considered not probable.
Recognition Principles of Contingent Liability: An enterprise should not recognize the contingent liability but it should be disclose in financial statement, unless the possibility of an outflow of resource embodying economic benefit is remote. In some cases an enterprise is jointly and severally liable for an obligation in that case, the part of the obligation that is expected to be met by other parties is treated as contingent liability. Contingent liabilities are continuously assessed and if it become probable that an outflow of future economic benefit will be required to settle obligation which is previously assessed as contingent liabilities, a provision is recognized. From the auditing point of view, the auditor should verify that a proper disclosure about contingent liabilities is made in financial statement as required by AS 29. As per, para 68 of AS 29 an enterprise should disclose for each class of contingent liability at the balances date.
- A brief description of the nature of the contingent liability and where practicable.
- An estimate of the amount as per measurement principle as prescribed for provision in AS 29.
- Indication of the uncertainty relating to outflow.
- The possibility of any reimbursement. If it is not practicable to disclose these brief, note that effect.
The Companies Act, 1956 requires disclosure of following liabilities by way of a note :
(1) Claims against the company not acknowledged as debts
(2) Uncalled liability on shares partly paid
(3) Arrears of fixed cumulative dividend.
(4) Estimated amount of contracts remaining to be executed on
(5) Other money for which the company is contingently liable.
The amount of any guarantees given by the company on behalf of directors or other officers of the company shall be stated and where practicable the general nature of each such contingent liability, if material shall also be specified. The apprehended liabilities aforementioned usually are not easy to ascertain unless a comprehensive knowledge in regard to the working of the business is acquired from a study of the Minute Book of Directors, files of correspondence with legal advisers and on collection of information from the of the company in regard to undisposed claims and legal actions pend