Valuation of Contingent Liabilities: Some Risk Management Considerations for Lenders

By Seigel, Benjamin S. | The RMA Journal, September 2005 | Go to article overview

Valuation of Contingent Liabilities: Some Risk Management Considerations for Lenders


Seigel, Benjamin S., The RMA Journal


Finding little information on valuating contingencies beyond FASB's Statement of Financial Accounting Standards No. 5--Accounting for Contingencies, the author, a California attorney, went on to tackle the problem for himself and now shares that information with Journal readers.

Lenders, at least the ones I know, seem to spend a great deal of time, effort, and money evaluating the asset section of their borrowers' balance sheets. They will frequently retain appraisers to provide values of such significant assets as:

* Furniture.

* Fixtures.

* Machinery.

* Equipment.

* Inventory.

* Accounts receivable.

* Patents.

* Trademarks.

* Copyrights.

* Customer lists.

* Real estate.

* Leasehold interests.

* Motor vehicles.

* Rolling stock.

Those lenders also attempt to determine the nature, extent, and validity of the borrower's liabilities, particularly accounts payable, accrued operating expenses, accrued salaries, other employee benefits, and whatever else the borrower or its accountants have chosen to state on the balance sheet.

However, I question the amount of attention devoted to the valuation of contingent liabilities--in particular, pending, threatened, and remotely potential litigation and governmental action--based on the lack of information available to assess their risks. The starting point for my analysis of this problem is the only writing of any substance I have found on the subject:

Statement of Financial Accounting Standards No. 5--Accounting for Contingencies, promulgated by the Financial Accounting Standards Board of the Financial Accounting Foundation.

Statement of Financial Accounting Standards No. 5 defines a contingency as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise. The uncertainty factor would ultimately be resolved when one or more future events occur or fail to occur. SFAS No.5 defines three classes of contingencies: probable (likely to occur), reasonably possible (more than remote but less than likely), and remote (slight chance of occurrence). Although SFAS5 teaches how to identify and report contingencies, it does not provide a standard for valuation of loss contingencies that can be used by a lender, nor does existing literature or law shed any light on such standards.

Some contingencies quickly become unwieldy and difficult to assess: expropriation of assets and catastrophes caused by weather, earth movements, plagues, famine, locusts, frogs, and other events of biblical proportions. Therefore, this article is confined to an exploration of the valuation of risks attendant to litigation and governmental action.

A Hypothetical Borrower

Question of Balance, Inc. (QBI) was formed 10 years ago by a group of high-net-worth engineers who had invented a vehicle that could operate on a combination of salt water, hydrogen, methane, and oxygen. After years of research and development work, QBI developed a prototype vehicle that could go 50 miles per hour for 10 hours at a time without refueling. The small vehicle held only the driver; chemical tanks and equipment used all remaining space. However, QBI was certain that with some additional R&D work, the size and passenger capacity could be increased and demand for the vehicle would be overwhelming.

So certain was the firm that it retained investment bankers to initiate an initial public offering (IPO) of its stock, engaged dealers in 20 states for its soon-to-be-produced four-passenger QBIMobile, and applied to Little Bank of Detroit (the Bank) for a $25 million loan to be repaid from the proceeds of the impending IPO.

While the loan application was being completed, the Securities & Exchange Commission (SEC) raised concerns about the disclosures in the Registration Statement filed in connection with the IPO and threatened to bring action against the company and its principals. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Valuation of Contingent Liabilities: Some Risk Management Considerations for Lenders
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.