Contingent liabilities arise in prepare their financial statements companies from the assumption of liabilities, such as guarantees , warranties , other warranty contracts or discounted bills of exchange, if the balance sheet date is uncertain if and when they become real liabilities. In the context of the debt crisis in Greece and other states, the contingent liability of states is also coming to the fore.
There are three forms of liability, namely real liabilities , provisions and contingent liabilities. They differ from one another in particular in the degree of probability of a payment obligation on the balance sheet date. If the obligation with the obligee shows that there is a direct legal or economic unavoidable obligation and the fulfillment of which constitutes an economic burden and is clearly quantifiable, then it is a question of real liabilities that must be shown on the liabilities side of the balance sheet with their fulfillment amount ( Section 266 (3) HGB). The probability of repayment of real liabilities is therefore 100%. The obligation to pay is less likely for provisions because the reason, amount and / or due date are uncertain. The element of uncertainty relates to the amount, existence or creation of a liability; In the case of liabilities subject to suspensive or dissolving conditions, it is not clear whether the condition will occur. However, there is no uncertainty in the person of the creditor; Uncertainty about the due date is irrelevant under the German Commercial Code (HGB), but under IAS 37 it also leads to disclosure as a provision. If the probability of payment is more than 50% and less than 100%, provisions must be set up in accordance with Section 253 (1) HGB.
Booking of contingent liabilities
If the probability of the obligation to pay is below 50%, this is a contingent liability. This gradation of probabilities corresponds to IAS 37 (English contingent liabilities ). In terms of content, contingent liabilities include those contingent liabilities in which the liable company is not a direct debtor at all , but instead is responsible for their debts alongside a debtor or in favor of a debtor . It can therefore be assumed that primarily the debtor will repay his own (real) liabilities alone, so that there will be no liability case in the first place.
For this reason, legislators in Germany and internationally have decided that contingent liabilities are to be recorded “under the balance sheet” ( Section 251 in conjunction with Section 268 (7) HGB). “Under the balance sheet” means that they are not part of the balance sheet total and therefore not part of the balance sheet, but must be listed below. Colloquially, the term “bottom line” is used, while special laws speak of “off-balance sheet business” ( Section 19 (1) Sentence 2 No. 3 and 4 KWG). As a result, they do not belong to the liabilities and therefore do not reduce the equity ratio or the net worth of a company. If the contingent liabilities of non-banks reach more than 50% of the equity capital , this liability position can be classified as questionable.
Types of Contingent Liabilities
In detail, the following basic forms of contingent liabilities were listed in Section 151 (5) AktG (old version):
- Liabilities from the issue and transfer of bills of exchange ,
- Liabilities from guarantees, bills of exchange and check guarantees,
- Liabilities from warranty contracts,
- Liability from the provision of securities for third-party liabilities.
In accordance with Art. 28 WG, at least the issuer is liable for payment of a bill of exchange in addition to the drawee , so that the legislature has decided to assign the bill of exchange and endorsement liabilities to contingent liabilities. If a company takes on sureties, guarantees or other warranty liabilities, the debtor from these transactions is primarily obliged to pay; this also applies to the “hard” letter of comfort . A warranty contract is an independent accounting term that includes every contract that cannot be qualified as a guarantee, by which the obligation is established to be responsible for a certain success or a service or for the non-occurrence of a certain disadvantage, insofar as this may involve an encumbrance of assets.
Special feature at credit institutions
Contingent liabilities play a special role at banks . According to § 26 RechKredV , the contingent liabilities for credit institutions are defined by a precise list. According to Section 26 (2) RechKredV, bidding and other guarantee obligations, binding letters of comfort, irrevocable letters of credit including the associated ancillary costs as well as letters of credit openings and confirmations are also part of the obligation to note contingent liabilities. They are to be noted in their full amount, provided that there are no earmarked credit balances under the item “Liabilities to banks” (liability item no. 1) or the item “other liabilities to customers” (liability item no. 2 b). Paragraph 3 deals with the "liability arising from the provision of collateral for third-party liabilities". This includes assignments of security , transfers by way of security and deposits for third-party liabilities as well as liabilities from the creation of liens on movable objects and rights as well as from mortgages for third-party liabilities. If there is also a liability from a guarantee or a warranty contract, only this is to be noted, namely in sub-item letter b “Liabilities from guarantees and warranty contracts”. All bank guarantees taken over by credit institutions are thus contingent liabilities.
Contingent Liability of a State
In the public discussion, the assumption of liability by states, in particular the Federal Republic of Germany , in favor of highly indebted European states has come to the fore. In comparison to companies assuming liability, states have the special feature that their state budgets are compiled in a cameralistic manner and the double accounting rules of the HGB do not apply in this respect . Pure households consist of income and expenditure, i.e. cash flows that affect liquidity. However, the assumption of contingent liabilities, such as the guarantee liability in favor of Greece, does not initially have an impact on the expenditure, as the guarantee does not result in an immediate payment obligation. Guarantees therefore only burden the budget if they are called upon, i.e. if a state should become insolvent and its creditors demand payment from the guarantee. Such federal guarantees require a legal basis.
The legal basis for these liabilities is the Monetary Union Financial Stability Act (WFStG), which came into force on May 8, 2010, and the Stabilization Mechanism Act . The necessary loans are granted by KfW Bankengruppe and guaranteed by the Federal Republic of Germany. Both laws contain authorizations according to which the government is entitled to provide guarantees for loans to Greece in order to maintain its solvency ( Section 1 (1) WFStG).
Contingent liabilities are not a specialty for states, however, because the exporter risks insured by the state as part of export credit insurance are also recorded as contingent liabilities of the state. As part of the so-called authorization procedure, the total amount covered by the state export credit insurance is determined annually in the federal budget . Up to a certain amount, Euler Hermes, as a so-called mandateur, is allowed to undertake coverage autonomously; in addition, an “Interministerial Committee for Export Guarantees (IMA)” has to decide. Since the client works on behalf of and for the account of the state, the coverage must be taken into account as a contingent liability in the federal budget.
If the primarily obligated debtor cannot or does not want to pay and there is a serious risk of a claim, companies must make a passivation as a provision for uncertain liabilities ( Section 249 (1) sentence 1 HGB). In that case, the creditor is entitled to a directly enforceable claim against the liable company, depending on the design of the warranty contract. This means that the contingent liabilities initially move one level higher in the provisions and thus become part of the balance sheet total. Finally, if there is a threat of direct claims arising from the assumption of liability, identification as genuine liabilities in accordance with Section 266 (3) HGB is required on the balance sheet date .