Understanding Contingent Liabilities and Risks Associated with them

The provided content discusses contingent liabilities and the actions taken by governments to preclude the fulfillment of contracts and sovereign default. The text highlights different types of financial guarantees, insurance programs, and government spending on natural disasters, as well as implicit guarantees like bailouts and deposit guarantees. It also mentions market failures due to unsatisfactory guidelines and information, irregularity in providing information, and externalities that require government intervention.

Define Contingent Liabilities?
The concept of contingent liability can be defined as the possibility of having certain or
uncertain risks associated with the financial record of an organisation. In other words, it
cannot be estimated from before and not in the hand of the businessmen. Rather, it is
depending on either past or future events.
A. Contingent liabilities is a legal contract that takes place either based on the episode or non-
occurrence of a probable prospect event. An organisation may not have any kind of control
measures prior to such events taking place in future.
B. In fact, a contingent liability is a suitable concept that might be depending on the past
event. In other words, not necessary that funds would always be ready to be released the
liabilities at emergency situation. Or else, it might not also be possible that a suitable budget is
planned before for uncertain compulsions.
Verification of Contingent Liabilities
Contingent liabilities have no scope of recording it into monetary report for an organisation.
In other words, such type of compulsions can be taking place in the near or far in future that
has no probable options to think about. Based on such conditions, some of the major
secretarial action has been initiated by providing some conventional approach. In this regard,
some of the contingent benefits will be disclosed at the end of footnote written by an
organisation. Hence, it would look like as follows:-
 There should be some promising commitment at present from the past event.
 The seepage of cost-effective possessions needs to be settled for managing the compulsions,
which are probable.
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 In fact, the possibility of seepage of resources should not be remote in nature.
 There need to be reasonable amount of requirement that can be estimated well.
Considering these above-mentioned approaches, the senior management team of the organisation
should be discussing and taking the decision that whether it can be contingent liability or even if
it is a liability in main concern.
Taking an example,
If a company gives a bank a guarantee period of three years of period, as subsidiary then for the
period mentioned it is accepted as a contingent liability. However, in the present date, the
company undergone financial disaster and there is no option left for the company to stay, as
contingent liability. In this case the company should be considering it as a provision and transfer
all the recorded details for recognition.
Contingent Liability and Provisions
Provision is a strategic responsibility that can be estimated with the help of reasonable amount
of budget. It tries to depict that there will be a compulsion but no specific amount that can be
determined. Therefore, such types of cases can be assumed as a provision for liability.
On the other hand, provisions can be secured in a book which is later on deducted under the
account of profit and loss. For example, provision for bad amount overdue or assessment is one
such incident.
Based on one particular scenario, provision cannot be secured in a book. If the liability is not
able to be calculated under any reliable base then such liability needs to be recorded as
contingent liability. Therefore, we cannot verify such cases, as a book of accounts, which is very
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rare in case. Hence, it can be further seen below comparing the differences between provisions
and contingent liabilities:-
Provisions:- Contingent Liability:-
Provisions are existing and current present
commitment with uncertain or liabilities but with
uncertain quantity. Here, the amount can be
precise with an extensive evaluation.
Contingent liabilities are potential duty. In such
case, it might take place at point of time. It will
be based on the incidence or non-occurrence of
definite occasions that cannot be controlled by an
organisation.
Provisions have possible scope of mitigating the
risks and meeting the identification criteria. It
refers to the books that can be regarded under this
book of accounts.
Contingent liabilities, on the other hand, are only
disclosed in the documents, as they are unable to
be net by the criterion.
When the management is estimating the
probability of the liability which will help in
settling the obligations then it will be resulting in
the economic outflow resources and is considered
as provision.
If the management is thinking that there are
possible chances of economic outflow.
Contingent liabilities are considered both to be explicit as well as implicit. Explicit contingent
liabilities are considered as the obligations which are on the base of contracts, policy
commitments as well as laws and regulations. The few expectations that the are being select
deliberately by the government are as follows:
 Loan guarantee: State guaranteeing for repaying the borrowing the third party only if
there is a default
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 Export Guarantee: Guarantee provided against reneging the importer’s contract and the
actions taken by the government which preclude the contract’s fulfilment as well as
sovereign default
 Other Financial guarantees: Guarantees provided against the rate of exchange,
guaranteeing the minimum pension on the ground of schemes of private pension, profit
as well as income. It also incorporates PPP arrangements as well as pension saving
guarantees.
 Insurance programs provided by governments: Insurance against the war risks
 Spending on the natural disaster: Government infrastructure like buildings, hospitals,
rods, universities and ports
 Uncalled capital: obligations for providing additional capital demands
Implicit capital contingent incorporates political as well as moral obligations sometime arise
from expectations that government would intervene in the event of a crisis or a disaster, or
when the opportunity cost of not intervening is considered to be unacceptable. Implicit
contingent liabilities include: • Bailouts of public enterprises, financial institutions,
subnational governments, and private firms that are either strategically important or “too big
to fail”; • Natural disaster relief, in the case of uninsured damage from natural disasters.
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Category of Conditional liabilities
There are three categories of contingent liabilities that support an organisation or a business
to deal with further procedure of legal matters. Probable liability is the one that estimates
about the possibility of being liable to someone for having the right of something. For
instance, a probable liability would rather be a conditional liability based on which a
company might be waiting for moving with the financial cost before estimating the
consequence.
The significant aspect of probable liability is to make sure about rational approximation of
the accountability. Some of the examples of liability are such as corporate taxes, rebates and
prizes that can be calculated within low cost budget. In addition, there are liabilities of
warranty of any kind of goods and products. In this kind of liability, some of the expenses are
accrued, which is later on incurred. Therefore, a supplementary financial document is
considered and kept, as record for further progress.
In case of Jay Company, as it produces household goods and gives a warranty of five years of
the quality of products, so it also keeps a probable budget assessment of the price of cash
amount, as per past fashion or history.
The second category is the possible liability that is not required to keep a track record or
documented in the form of balance sheet. In other words, possible liability can be easily
noted down in the form of a memorandum to be read, as monetary testimonial.
Based on an example, if a company selling a washing machine to a customer and gives
guarantee of high scale services, but finds after one year that the washing machine does not
work and complaints against the brand name and legally threats to claim the amount of
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money or replacing the machine, then it cannot be estimated about the time period and the
amount of penalty to be paid by the company to the customers. According to the decision
taken by the court, it can be imagined not assured about the compensation money or about the
procedure of the court to be initiated legally in future events. In fact, any kind of issues
related to possible liability can be thought of before and planned with certainty. As a result,
possible liability has possibility to reveal it in the form of file to the financial report.
The third liability is the remote liability, which has no chance of possibility or probability. In
case of Jay Company, if the organisation seems to be clueless in terms of evidence or without
value, then the Company has less scope of losing it by law. According to generally accepted
accounting principles (GAAP) no additional entrance to be put on the balance sheet and no
other communication is to be verified in the monetary declaration.
Extenuating Threats Related to Contingent Liabilities:-
Risks associated with contingent liabilities cannot be regarded as a suitable option for the
government. In other words, large numbers of countries are unanimously involved with
contingent liabilities and its interlinked hazards. In that case, it becomes important in the
matter that relating the accurate category of conditional liability and the reason behind
choosing such option. Some potential practices like transferring the risks to some promising
private sector such as early parliamentary process can be beneficial for safeguarding the
number of risks associated with the contingent liabilities. Other than this, a strategic thinker
and decision-maker would require for identifying the nature of threat and provide with
adequate guidelines for incorporating it into practice. Apart from this, there need to be
preferable support that is expected to be traced back in order after a suitable decision is taken
with regard to the contingent liabilities for the function of responsibility.
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Most of the countries have taken initiative agenda for reducing the number of risk under an
inclusive strategy. For example, Australia is one such country that has lawfully proposed and
developed some strategic direction before entering into an issuance under the control of the
guarantees and other dependent responsibility as well. In other words, the condition is that the
Government would not enter into any kind of agreement unless there is any particular risk is
visible or recognized well. In addition, some private agencies have to consider the specific
amount of risk to be identified as well as the degree of loses need to be recovered as well.
Further, it can be investigated that the nation is highly secured and the Government bearded
some of the cost of threats and increased value for money and at the same time, a proper risk
management planning seems to be in proper place.
Which is the right time to take Contingent Liabilities?
This can be understood from the above discussion that when there is a malfunction of market,
as per Government’s opinion, it is the correct time period of initiating contingent liabilities.
In this regard, market failure indicates that there is lack of sufficient allocation of resources to
be achievable by an individual. Hence, some of the failure that is generated for the below
mentioned reasons:-
Unsatisfactory guidelines and information:
It generally happens during the time of high price information-based work where the agents
are mostly attracted to provide, incomplete or inaccurate information that creates issue with
incompetent distribution of resources. In other words, it means that the market running under
credit worthy borrowers might not get admittance to credit market. At the same time, some
beneficial projects can also be left unfunded as well.
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On the other hand, the market worthiness can be well grown and developed by the help and
support of the Government at low price than private markets. Further, there can be more
efficient options of getting loan under the private parties and payment collection department.
However, it might not provide any guarantee to the loan borrower after acquiring the loan
amount as well. Therefore, the Government would need to focus on being more efficient with
underwriting risk or collection of loan. Apart from this, the Government can also use some
other technical tools for dealing with the defective information. It means that more efficient
underwriter is necessary than any private lenders to gain proper information about the market.
Irregularity in providing information:
In this type of symmetric information, it occurs that some of the parties provide uneven
information in case of signing a contract. Other than this, most of the agents are not proficient
in taking up good amount of information during a contract. This happens mainly in the
insurance market dealing with monetary transactions or in case of any kind of material
insurance. For example, due to some lack of efficient flood insurance in an area, this is full
of flood or crop production fail to claim insurance from the insurance companies. Similarly,
insurance for farming land by the farmers are also affected badly during the flood and not
recovered from insurance office.
One of the biggest examples of this category is that failure attempt to secure the insurance
amount that has been damaged from terrorist attack in the year 2001 11th September. Based
on that serious incident, the US Government has been requested to adopt a strategic decision
to start sharing wide number of financial losses in association with the insurance industry in
case of major assault. Hence, two of the major program has been introduced in the market,
one is temporary airline loan guarantee and the other is the large-scale guarantee program for
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SMEs at the time of economic downturn took place in Japan. Therefore, both the programs
can be useful in terms of mitigating the risks taken by the Government of a country.
Existence of Externalities:
In terms of Externalities, it tries to depend on some of the prices of social expenses and
reimbursement. These are not placed with prices in the market and so they happen to be in a
state of intervention. Based on this concept, the Government would need to apply some
serious intrusion that could facilitate by challenging or sponsoring such activity. It can be
justified under these subsidised guarantees. It can be recognised that most of the activities are
available that gives right promotion of economic growth and progress. Such activities are laid
under EU state supportive rules. In other words, some of the progressive events under these
rules are for example, enhancing the backward regions and encouraging the SMEs. Other
than these, there can be research and development practices, training session for employment
and saving the environment as well. Such types of activities and practices are considered, as
positive outcome, which are likely to recover any kind of damages in future.
Moreover, some negative externalities can be considered such as the failure of bank cases or
any other social legal procedures like bailouts or deposit guarantees. Apart from these, there
are some external factors like bank disruptions due to the loss of funds or increasing ratio of
debts within the bank customers are once again important to be noticed. Progressing for
economic development is significant for the sake of the customers. Therefore, such defensive
instrument can reduce the ratio of bank insolvency in a proper manner.
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