By MIA PAIB and Valuation Department
In frequently asked questions regarding the treatment of contingent liabilities in a solvency test under the Companies Act 2016 (CA2016), the following issue often comes up:
Should contingent liabilities be included as part of the solvency test under Section 112 of the CA2016? A question arises pertaining to the measurement of contingent liabilities which are not separately recognised in the financial statements for the purpose of the solvency test.
There is a specific provision under Section 113(4) of the CA2016 which states that “in forming an opinion for the purpose of making a solvency statement, a director shall inquire into the company’s state of affairs and prospects and take into account all the liabilities of the company including contingent liabilities”. Hence, contingent liabilities are included as part of the template for solvency statements provided by Suruhanjaya Syarikat Malaysia in addition to assets and liabilities.
The question is how such contingent liabilities would be treated in the template for the solvency test. Under the accounting rules, for contingent liabilities which form part of an acquisition, there is a fair value attached to it for the purpose of recognition in the financial statements. However, there may be other contingent liabilities that are not recognised in the financial statements but only disclosed in the notes to the financial statements. A case in point would be a legal case that is being brought against the reporting entity for which the future outflow of resources is possible but not considered remote.
There could be a situation where even if the full value of the contingent liability is taken into account, a company would still be in a positive position. In such a case, there would be no apparent issue. However, if the amount of the contingent liability is significant, it may cause a negative position to arise.
By referring to Section 112(1)(b) of the CA2016 on the prescribed period of 12 months, the consideration is the ability of the company to pay its debts as the debts become due during the period of 12 months immediately following the date of a particular transaction.
Hence, the window period is actually 12 months, and the consideration is whether such a contingent liability is going to materialise within the 12 months’ period.
The measurement and disclosure of contingent liabilities in the solvency statement is to safeguard the company from becoming insolvent within that prescribed timeframe as required under the CA2016.
It is at the company’s discretion to decide whether a contingent liability is to be included or not to be included in the solvency statement. Ultimately, the directors will be responsible for the veracity of the solvency statement, and they are liable if it fails to meet the requirements of the CA2016.