Contingent liabilities are those liabilities that are expected to accrue in future due to the expected eventualities such as pending legal suits, obsolescence of assets among others. These possible obligations arise from past events undertaken by the organization and whose occurrences are subject to uncertain future events which the organization cannot fully control. According to International Public Sector Accounting Standard (IPSAS) 19, all those public entities which prepare their financial statement on accrual basis are expected to disclose their contingent liabilities in the financial statements.
Consideration of contingent liabilities by the users of financial statements affects making of financial decision. This is because more often than not, users of financial statements concentrate on the risks posed by the disclosed contingent liabilities. They therefore adopt challenging approaches especially when faced with probability of incurring heavy losses. According to a study conducted by a Lacy (2003), the users of financial statements are faced with ambiguity about contingent liabilities and they think in terms of losses likely to be incurred unlike the auditor who in their reports gives an independent view of the statements. Therefore, the contingent liabilities forms a criteria of making financial decisions and it is likely that the users are likely to make wrong decisions if they fail to consult the audit report.
Another example is given in the research conducted by Brown & Hillegeist (2007) which concluded that disclosure affects the asymmetry of information. This means that if disclosures on contingent liabilities are not supplemented with all relevant information, the user is likely to make conservative financial decisions which are not necessarily the right decisions. According to another research conducted by Burnside in 2001, consideration of contingent liabilities creates obligations for the state such as financial costs. The government as a user of such disclosure will therefore make decisions that prevent the foreseen event from happening to prevent losses.
Burnside A C. 2001,Currency Crisis and Contingent Liabilities, Working paper (Organized by the Croatian National Bank).
Brown S. and Hillegeist, S. A. (2007), How Disclosure Quality Affects the Level of Information Asymmetry, Review of Accounting Studies, vol. 12 No. (2-3) pp. 443–477.
Lacy J. Y. (2002), Probability Expression and Ambiguity: An Experimental Study of Disclosure Perceptions for Contingent Liabilities, PhD Thesis, George Washington University.