Finance & Accounting

An overview of Contingent Liabilities and Commitments

The books of accounts do not recognise contingent liabilities. However, in Ind AS-37 Provisions, Contingent Liabilities and Contingent Assets, it is necessary to make disclosures of contingent liability in the Financial Statements if the possibility of an outflow of resources embodying economic benefits is not remote. Moreover, disclosures related to various commitments such as Capital Commitments, other commitments and uncalled liability of shares have been made necessary under Ind AS Schedule III.

What is Contingent Liabilities under AS 37?

AS 37 defines contingent liabilities as:

1. A possible obligation that arises from the past events and whose existence shall be confirmed only on the non-occurrence or occurrence of one or more uncertain future events which are not wholly within the entity’s control; or
2. A present obligation which arises from past events but has not been recognised because:

• It isn’t probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
• The amount of the obligation can’t be measured with sufficient reliability.  

For example, an assessee challenged the demand raise by the tax authority in the court. The court’s decision will determine the liability. This pending court case shall be a possible obligation that arises from the past events and only after the court gives its decisions that its existence will be confirmed.

What is Commitments under Schedule III?

The term ‘Commitment’ has not been defined in Schedule III. It is only in the glossary of terms used in Financial Statements which has been issued by ICAI^[1] that the term ‘capital commitment’ has been defined as future liability for capital expenditure in respect of which contracts have been made. Drawing reference from the definition of capital commitment, ‘commitment’ can be defined as future liability for contractual expenditure. In the same manner, ‘other commitments’ will include all the expenditure related contractual commitments excluding capital commitments such as commitments that arise from long term contracts for purchasing of raw material, lease commitments, employee contracts etc.

Classification of Contingent Liabilities  

The Contingent Liabilities can be classified in the following manner:

1. Guarantees excluding financial guarantees
2. Claims against the company which are not acknowledged as debts
3. Other money for which company is contingently liable

Classification of Commitments

The Commitments can be classified in the following manner:

1. Uncalled liability on shares and other investments which are partly paid
2. Estimated amount of contracts that remain to be executed on capital account and not provided for
3. Other Commitments (specific nature)

Contingent Liabilities with respect to guarantees

The contractual liabilities arise when a company gives guarantees to another person on behalf of the third person. For example: when a company becomes the guarantor for a loan being given to a subsidiary, or another company or guarantees that another company will perform its contractual obligations.

However, this guarantee cannot be taken by the company for performing its own obligations. This will not come within the purview of contingent liabilities and as a result cannot be reflected as contingent liability in the company’s balance sheet.

Ind AS 109, Financial Instruments recognise financial guarantees on the balance sheet. Therefore, all guarantees other than financial guarantees are to be disclosed as part of contingent liabilities on the company’s balance sheet.

‘other commitments’

The ‘other commitments’ must only include those non-cancellable contractual commitments (i.e. cancellation of which results in levying of penalty which is disproportionate to the benefits involved) based on professional judgment of the management and also which are material in understanding the Financial  Statements of the company’ financial statements. For example, Commitments can be in the nature of commitment to fund subsidiaries and associates, commitment in the nature of buyback arrangements, derivative related commitments, non-disposal of investments in subsidiaries and undertakings etc. It must be noted that disclosures related to lease commitments for non-cancellable leases shall be given in accordance with Ind AS 116, Leases.

Moreover, according to Ind AS Schedule III, separate disclosure of the amount of dividends proposed to be distributed to both equity and preference shareholders for the period and the related amount per share needs to be made.

In cases where the securities have been issued for a specific purpose and if the whole or any portion of that amount has not been used for a specific purpose at the balance sheet date, then disclosure of the same shall be indicated by way of note, disclosing, how such unutilized amount have been used or invested.

Also in those cases where the borrowings have been drawn from the banks and other financial institutions for a specific purpose, and the same have not been used for that specific purpose, then the borrower company needs to make disclosure as to tell where the amount has been utilized. However, it is not necessary to provide in detail one-to-one relationship with the amount of borrowing and its utilization. Rather, disclosure should be made in a manner to give an overall position of the balance sheet at the reporting period.

Conclusion

Though it has not been made mandatory to recognise contingent liabilities in the books of accounts, yet AS-37 make it necessary to make disclosures if the possibility of an outflow of resources comprising economic benefits is not remote. 

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