| Kind of Contingent Liability | Amount |
| Upon customers’ notes discounted, sold, | |
| or otherwise transferred | $ ...... |
| Upon drafts negotiated | ...... |
| For accommodation indorsements | ...... |
| For guarantees | ...... |
| Upon leases | ...... |
| Upon bonds or other obligations of | ...... |
| subsidiary companies | ...... |
| Under contracts or purchase arrangements | ...... |
| Under agreements | ...... |
| Under pending lawsuits | ...... |
This company is not a guarantor or indorser of any liabilities or | |
| Sign Company’s name here .......................................................... | |
| By .......................... | |
| N. B. It is most essential that each question be fully answered. | |
Full answers to the above inquisition would often prove embarrassing but very enlightening. Two additional kinds of contingent liability not listed above sometimes exist, viz.: that arising out of a call for the unpaid portion of stocks owned but not fully paid for; and in the case of a corporation, unpaid accumulated dividends on preferred stocks. Some of these contingent liabilities require detailed consideration.
Notes and Drafts Transferred
The proper method of handling notes discounted, sold, or otherwise transferred, and negotiated drafts is given in Volume I and will not be repeated here. The showing of these items on the balance sheet is by inclusion among both the assets and liabilities, or preferably by inclusion among the assets with the liability element shown deducted. When a person or firm lends its credit by means of an accommodation indorsement, the transaction should be recorded as a charge to the accommodated party and a credit to Notes Payable if the liability is primary; or to Indorser’s Liability, if secondary. In case of primary liability, liability is full and must be listed on the balance sheet as a note payable. In case of secondary liability, liability is contingent, as in the case of discounted notes, and should be so shown on the balance sheet. In either of these cases, the practice of cancelling the liability against the corresponding asset and by a feat of mental dexterity persuading oneself that there is therefore no need to show the item on the balance sheet, is a practice to be universally condemned.
Guarantees as a Contingent Liability
Guarantees are of many sorts—guarantees of product sold or work performed, guarantees of the good faith of others in meeting their obligations, etc. The transferred note is one kind of guarantee. Oftentimes, a parent company may guarantee the principal and interest or the interest only of the bond or note obligations of a subsidiary. While the expectation is usually that the contingent liability will not become real, yet experience shows the need of making adequate provision against it. The recent example of the Denver & Rio Grande as guarantor of the bond interest of Western Pacific bonds drives home that necessity. In a case of this sort provision is best made in the creation of a contingency reserve, for there is no experience on which to base a better estimate. In the case of a policy of guaranteeing the quality of a product or its workmanship, after a few years’ experience very accurate estimates can be made of the loss to be expected therefrom, and at the end of a fiscal period the books can be adjusted on that basis just as they are for taxes. A charge to a suitable expense account and a credit to a reserve or accrued account comprises the book entry, with a listing of the reserve as a real liability.
Long-Term Leases
Contingent liability brought about by a lease covering a long period may be disregarded if the lease has a marketable value sufficient to cover the liability. Otherwise a contingent reserve should be set up. Liability under the subletting of a lease is best handled by means of a reserve.
Purchases for Future Delivery
Purchase contracts for future delivery, if made at a fixed price, may be disregarded unless at the date of the balance sheet market value is lower than cost, when a reserve should be set up. A fuller statement of the facts shows the transaction among both assets and liabilities. If the contract, being speculative, is not at a named price, the showing of the reserve is prudent and conservative.