Q14: What are the three types of contingent liabilities?

A:

There are three types of contingent liabilities (one of which is very rare, in practice). These three types of contingent liabilities are:

“(a)  a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

(b)    a present obligation that arises from past events but is not recognised because:

(i)     it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

(ii)    the amount of the obligation cannot be measured with sufficient reliability.”

AASB 137 para 10

The first type of contingent liability does not yet exist as a liability. Its existence as a liability is contingent on, that is depends on, a future event occurring. These are possibly the most common form of contingent liabilities our firms might have; but they are not the only type of contingent liability.

We can also have contingent liabilities where there is an existing ‘present’ obligation arising from a ‘past’ event but where it fails to ‘win’ the quinella (probable and measured reliably) to be recognised (ie included) as a liability in a firm’s financial statements.

These types of contingent liabilities are almost always items that would, indeed, likely be a provision except that it is not probable (ie less than 50% probable) resources will be expended to settle the obligation.

The second leg of the quinella to be recognised as a liability is to be able to be ‘measured reliably’. The accounting standards make it clear that it is ‘extremely rare’ (AASB 137 para 25) that our firm will not be able to ‘make an estimate of the obligation that is sufficiently reliable to use in recognising a provision’ (AASB 137 para 25). In this way, the quinella of recognising or including a liability in a firm’s financial statements has in almost all cases simply one leg to it (‘probable’); a sort of ‘one-legged’ quinella in most cases. Only ‘[I]n the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability…’ (AASB 137 para 26).

Study Guide Chap 5 page 6-17 & 16-8