What is the difference between a provision and a contingent liability?

A provision is recognised on the balance sheet because an outflow is probable and can be reliably estimated. A contingent liability stays off the balance sheet, either because the obligation is only possible or because the outflow is not probable or cannot be measured reliably. It is disclosed in the notes unless the chance of an outflow is remote. The classification can change from one reporting date to the next.

Is a guarantee a contingent liability?

Commercially, yes: it is a promise to pay if something else happens. For accounting purposes it depends on the guarantee and the framework. Under IFRS, a guarantee of another party's debt is usually a financial guarantee contract under IFRS 9 and is measured on the balance sheet. Other guarantees, such as those of performance, may fall under other standards. In the UK, FRS 102 generally applies section 21 to financial guarantees unless financial instruments standards have been chosen.

Do lenders count contingent liabilities as debt?

Not automatically. Covenant definitions usually state what counts, and many include guarantees of borrowed money while excluding trade bonds up to a limit. For its own assessment, a lender normally goes further and estimates what might crystallise in a bad year, adding that to debt and reducing earnings. The purpose is to test whether the business could carry the claim, not to restate its accounts.

When does a contingent liability not need to be disclosed?

When the possibility of an outflow is remote. The term is a matter of judgement and the standards do not assign it a percentage. In extremely rare cases, a company may also withhold details that would seriously prejudice its position in a dispute, while stating the general nature of the dispute. A lender with a material concern therefore asks directly and does not rely on silence in the note.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Contingent Liabilities: a Worked Example

Each item is unlikely. The trouble is that they travel together.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-09 · 6 MIN READ

// THE SHORT ANSWER

A lender cannot find these obligations in the debt figure, so it goes to the notes, and asks what would have to happen for each to become cash. A bond or a lawsuit may come to nothing. Added at face value they overstate the risk; ignored, they understate it. The useful reading sits between: a judgement about what would land in a bad year, added to debt, with earnings cut to match, since the same downturn tends to bring both.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

// MAKE THE CALL

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PART OF Credit Analysis for Beginners

// 01 — WHY A LENDER READS THE NOTE

A balance sheet records what a business owes. The contingencies note records what it might come to owe, and for a lender that distinction can be thin. A contingent claim competes with the lender for the same cash once it crystallises, and it tends to crystallise when the business is already short of cash. The accounts leave these items out of debt for good reasons, but leverage and interest cover calculated from the balance sheet will not show them.

// 02 — WHAT THE ACCOUNTS RECORD, AND WHAT THEY LEAVE OUT

Outflow probable, amount measurable → provision, on the balance sheet

Outflow possible, not probable → contingent liability, in the notes

Outflow remote → no disclosure required

That sequence comes from IAS 37 (NZ IAS 37 and AASB 137 locally) and, in similar terms, section 21 of FRS 102 in the UK. Each stops short of telling a lender what it wants to know. If the directors judge a call remote, the item need not appear. Where it does appear, the standard asks for an estimate of the financial effect only where practicable. And the probability judgement is management's own, made at the balance date.

A guarantee of someone else's debt needs care, because it may not be a contingent liability in the accounting sense. Under IFRS, a contract requiring the issuer to reimburse a holder for a specified debtor's failure to pay is a financial guarantee contract, within IFRS 9, and carries an amount on the balance sheet that may be small. FRS 102 generally brings such contracts under section 21, unless the entity has chosen the financial instruments standards. Small UK companies must state the total of guarantees and contingencies not on the balance sheet. Special-purpose accounts, common among smaller New Zealand and Australian companies, may say less. The lender therefore asks for a schedule, and if it issued the bonds itself it already holds part of the answer.

// 03 — THE EXAMPLE

A road-surfacing contractor, constructed for this page like every figure in it, has debt of US$14.0m and EBITDA of US$7.0m. Its note lists US$8.0m of performance bonds issued by its bank for council contracts, a US$2.5m guarantee of a loan to a plant-hire company owned by its directors, and a US$1.5m claim over a failed surface, which the directors, on legal advice, think unlikely to succeed. The lender sets out a bad year: one contract lost and 20% of the bonds called, the plant-hire company unable to pay, the claim settled for US$0.9m, and EBITDA down to US$4.5m. The assumptions are the example's.

US$m Face Bad year

Performance bonds 8.0 1.6 (20% of face)

Plant-hire guarantee 2.5 2.5

Claim 1.5 0.9

Total 12.0 5.0

As reported: 14.0 ÷ 7.0 = 2.00×

Everything at face: (14.0 + 12.0) ÷ 7.0 = 3.71×

Bad year, earnings held: (14.0 + 5.0) ÷ 7.0 = 2.71×

Bad year, earnings cut: (14.0 + 5.0) ÷ 4.5 = 4.22×

The line at face value is the wrong test. It assumes every bond is called, which in practice means the contractor failing on every contract at once. The third line adds the bad-year amounts but leaves earnings alone, as if bonds were called in a good year. The last line is the one the lender wants, because the same events that bring the calls also hurt earnings: a lost contract takes its margin with it. A bond called is also cash, due at once, as the bank pays the beneficiary and claims on the contractor's counter-indemnity. If the working capital line is fully drawn, that claim has nowhere to go.

// 04 — HOW IT DIFFERS FROM A PROVISION AND A COMMITMENT

A provision is a liability already on the balance sheet: the outflow is probable and can be estimated. A contingent liability has not reached that point, and an item can move from one to the other as facts change, for instance when a court rules. A capital commitment is different again, since it is an amount the business has agreed to spend, with no uncertain event involved, and it pays for something the business will receive.

Debt-like items overlap in practice: a buyer of a business may treat a live claim as a deduction from price. The two sides of a bond should also be kept apart. To the contractor it is a contingent obligation. To the bank that issues it, it is an off-balance-sheet exposure that uses up a limit and attracts a capital charge even if it is not called.

DEFINED IN ONE PARAGRAPH → · THE PERFORMANCE BOND → · BANK GUARANTEE, THE PRODUCT →

// 05 — WHERE IT DECIDES A FILE

The first question is who the promise benefits. A bond for the contractor's own work is a cost of being in the trade, and whether it is called turns largely on the contractor's own performance, though an on-demand bond can be called without proof of breach. A guarantee of a directors' company is a different risk: the lender is exposed to a business it has not assessed, and it is reasonable for it to ask for that company's accounts, or for the guarantee to be released or capped.

The second place is the document. A definition of financial indebtedness often includes guarantees of debt, and in many agreements excludes bonds issued in the ordinary course of trading, up to a limit. Many facilities also restrict new guarantees. A failure to pay a called bond or guarantee can trigger cross-default, which is the mechanism by which a contingent item can reach the main loan. The third is the bank confirmation and the auditor's enquiries, which help check that the note is complete. A lender reading the accounts sets the note beside the previous year's, because a growing list deserves an explanation even where each item seems unlikely.

FINANCIAL REPORTING, READ BY A LENDER → · CROSS-GUARANTEE →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Australian Accounting Standards Board, AASB 137 Provisions, Contingent Liabilities and Contingent Assets (compiled), the Australian text of IAS 37 — paragraphs 10, 27, 28, 86 and 92 — Defines a contingent liability, bars its recognition, and requires disclosure unless an outflow is remote — section 02.
IFRS Interpretations Committee, Guarantees Issued on Obligations of Other Entities, agenda decision, April 2025 — Sets out how an issuer first considers whether a guarantee is a financial guarantee contract under IFRS 9 before looking to other standards — section 02.
Financial Reporting Council, FRS 102 (September 2024 edition) — paragraphs 21.1A, 21.12, 21.15, 1AC.29 and 1AC.31C — Sets the UK treatment of contingent liabilities and financial guarantee contracts, and the small-entity disclosures — section 02.

// QUESTIONS PEOPLE ASK

What is the difference between a provision and a contingent liability?: A provision is recognised on the balance sheet because an outflow is probable and can be reliably estimated. A contingent liability stays off the balance sheet, either because the obligation is only possible or because the outflow is not probable or cannot be measured reliably. It is disclosed in the notes unless the chance of an outflow is remote. The classification can change from one reporting date to the next.
Is a guarantee a contingent liability?: Commercially, yes: it is a promise to pay if something else happens. For accounting purposes it depends on the guarantee and the framework. Under IFRS, a guarantee of another party's debt is usually a financial guarantee contract under IFRS 9 and is measured on the balance sheet. Other guarantees, such as those of performance, may fall under other standards. In the UK, FRS 102 generally applies section 21 to financial guarantees unless financial instruments standards have been chosen.
Do lenders count contingent liabilities as debt?: Not automatically. Covenant definitions usually state what counts, and many include guarantees of borrowed money while excluding trade bonds up to a limit. For its own assessment, a lender normally goes further and estimates what might crystallise in a bad year, adding that to debt and reducing earnings. The purpose is to test whether the business could carry the claim, not to restate its accounts.
When does a contingent liability not need to be disclosed?: When the possibility of an outflow is remote. The term is a matter of judgement and the standards do not assign it a percentage. In extremely rare cases, a company may also withhold details that would seriously prejudice its position in a dispute, while stating the general nature of the dispute. A lender with a material concern therefore asks directly and does not rely on silence in the note.

// NEXT TO IT

// ON WHOSE DESK

The seats that read this term in an ordinary week. Each page says what the seat is for, who arrives in it, and the shape of the round it runs.

Transaction bankerSells and structures the plumbing a business runs on — accounts, payments, collections, liquidity and trade finance.
Personal bankerThe bank's face in a branch or on a phone: everyday accounts, cards, personal lending and the first conversation about a home loan.
Operations analystRuns the processing every product depends on — payments, onboarding, settlements, servicing — at volume.

THE IN-TRAY · ONE MINUTE

Make the call on one file.

A short file on the ground this page covers. Every option opens with how far it sits from a senior banker’s read.

THE FIRST QUESTION · THE BORROWER · EARNINGS

A travel agent now reports only its commission as revenue, instead of the full price of the holidays it sells. Revenue fell from US$80m to US$12m; profit is unchanged.

What happened to the business?

6 MORE ON THE BORROWER · EARNINGS →WHERE DO YOU READ FROM? THE PLACEMENT →

THE READING ROOMIN ONE PARAGRAPHContingent liabilities What are contingent liabilities, and how does a lender treat them?