Archive for June, 2011

The cultural context of contingencies

Thursday, June 2nd, 2011

What we are trying here in this blog is to find a common language in NPO accounting and auditing, across cultural boundaries.

One term that is of special interest to me is the term “contingencies”. What are contingencies? Well, there are – at least – two definitions of this English word: one that is American and one – international one.

The American definition is defined in SFAS 5, IFRS defines provisions and contingencies in IAS 37. Both definitions have something in common. They deal with uncertainties [1] [2] . How to reflect uncertainties in the financial statements? – That is the question here. 

However, there are differences in the terminology. In IFRS parlance, two terms – provisions and contingent liabilities[3] – cover more or less what is called contingency in US-GAAP speak. The differences between both definitions are aptly described in J. Russell Madray´s “IFRS Essentials with GAAP comparison”, AICPA 2010.

As a rule of thumb we can say:

What an American CPAs regards as a contingency that is probable (i.e. likely to occur) is a provision for IFRS.

Probability is described as “likely to occur”, as stated in the US GAAP, or “more likely than not”, as stated in the IFRS.

In both frameworks, a contingency of this kind (i.e. a provision or a probable contingency) has to be recorded in the “corpus” of the financial statements.

What is reasonably possible (i.e. it is more than remote, but less than likely) has to be disclosed in the notes.

What has only a slight chance to occur can be ignored – in both standard frameworks.

In other words, US GAAP and IFRS have the same “triage”[4] of classification.

But here the problems start: what is reasonably possible? There are different ways of defining what is reasonably possible. For instance, our German energy suppliers do not believe that a nuclear meltdown of a German nuclear power plant is reasonably possible. On the other hand, our insurance companies do not insure our energy suppliers against such a nuclear disaster: there is no reasonable way to calculate an insurance provision, or – probably more correct in mathematical terms – the insurance premium would be so high that this would be the end of all nuclear power plants in Germany. I think you see the contradiction: nuclear experts say that the risk is extremely remote, thus it can be ignored. Insurance experts say that the risk is so incalculable that it is not a business. As a result, the risk remains unaccounted. It is not billed into our energy prices.

Our world is founded on the concept of individual responsibility, but in certain areas we deviate from this concept. In other words, Western civilizations have this cultural perception that remote disaster risks do not have to be taken into account with regard to the individual entity. The result is that – to use a popular saying – the costs of high risks are collectivized, while the chances for profit are privatized. The American economist Mr. Joseph Stiglitz saw parallels with the crash of 2008 in this. Well… my question at this point is: Why don’t we have a financial instrument, a super-sophisticated derivative, where I can bet on a nuclear disaster in Germany? This was, of course, a cynical question.

Our readers in other continents should understand that our – for instance “German” – perceptions of what is reasonable are full of – sometimes breathtaking – contradictions. All that auditors can do is drawing attention to these contradictions. At least, the risks should be addressed.

Here are some other artifacts of field definitions of contingencies:

Case 1: In country X, a charity runs an orphanage. There are no special provisions in the tax code for supporting orphans in this country. Is the support taxable income of the orphans? In accordance with the letters of the law it is, auditors say. However, who would tax orphans for their food subsistence? No politician would survive such an administrative hype. I would interpret these circumstances as a contingent liability, and not as a provision. Why? Because there are general standards like “reasonableness” in all cultures. Formally, it would be a liability. In substance, it would be a contingency. As you can see here: Contingencies have a lot to do with a “civil rights” position. What is your opinion in this case?

Case 2: A businessmen in country X confesses during the audit that he has paid bribes to government officials over the last two decades. He does not disclose the related liabilities (unpaid income tax, fines, legal consequences), because “the chances are so remote that this will discovered in our country. And even if it is discovered, it could be regulated with some small extra payments. These extra-payments will not be material.” Is this acceptable? The emerging contingencies have to be recorded, I would say. What would you say?

Case 3: An NPO in country Y wishes to adapt IFRS. How to identify contingencies? The director explains: “Look! We do not live under the rule of law. Laws are contradictive, they are not regularly executed, and informal solutions prevail. Of course, tomorrow, this office could be closed by the tax police, if they wanted to do that, and all assets could be confiscated. There are frequent examples of this. Is this a contingency? What do you want from me?!” Well, US GAAP says that general business risks do not have to be recorded. This means that in this country the high inherent risks do not have to be reported.

What do you say? I mean, in this case, only the extremely high risks have to be reported. And the deadly risks. If somebody is left who can report them.

Please feel free to add other examples from the field.

Frank Fabel, CPA


[1] IAS 37 defines “provisions as liabilities of uncertain timing or amount”. The cross cultural approach of the standard is very nice: “In some countries the term ’provision‘ is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Standard.” (


[2] FASB 5 determines “For the purpose of this Statement, a contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (hereinafter a “gain contingency”) or loss”. (


[3] IAS 32 distinguishes between:

“(a) provisions – which are recognised as liabilities (assuming that a reliable estimate can be made) because they are present obligations and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations; and

(b) contingent liabilities – which are not recognised as liabilities because they are either:

(i) possible obligations, as it has yet to be confirmed whether the enterprise has a present obligation that could lead to an outflow of resources embodying economic benefits; or

(ii) present obligations that do not meet the recognition criteria in this Standard (because either it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made).” ( 



[4] „Triage“ is a medical term. Triage describes the selection of patients into three categories, in emergency situations. Patients are selected into categories of “may survive without emergency help”, “all help comes to late” and “emergency measures are useful”. In some cases, I had the feeling that our selection process in the financial world is very similar to this process in the medical world.