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lt1776 · 12-07-2009, 04:18 PM

I have a question about contingent liabilities. FAS 5 par. 12 states:

12. Certain loss contingencies are presently being disclosed in ﬁnancial statements even though the possibility of loss may be remote. The common characteristic of those contingencies is a guarantee, normally with a right to proceed against an outside party in the event that the guarantor is called upon to satisfy the guarantee. Examples include (a) guarantees of indebtedness of others, (b) obligations of commercial banks under “standby letters of credit,” and (c) guarantees to repurchase receivables (or, in some cases, to repurchase the related property) that have been sold or otherwise assigned. The Board concludes that disclosure of those loss contingencies, and others that in substance have the same characteristic, shall be continued.

It says that "Standby Letters of Credit" are contingent liabilities, however, it seems like Standby Letters of Credit are more like contingent assets. If a bank holds a standby LoC, and the standby LoC is activated, then the bank will pay on behalf of the borrower. Then the bank will convert the amount it pays out into a loan, which the original party of the standby LoC will be obligated to pay back.

This is my understanding. Does anybody know why FASB classifies standby LoC as contingent liabilities?

Here is a link where I learned about Standby LoC:

12-07-2009, 04:18 PM	#1 (permalink)
lt1776 Status: n00b Join Date: Oct 2009 Posts: 10 Rep Power: 0	Contingent Liabilities - Question I have a question about contingent liabilities. FAS 5 par. 12 states: 12. Certain loss contingencies are presently being disclosed in ﬁnancial statements even though the possibility of loss may be remote. The common characteristic of those contingencies is a guarantee, normally with a right to proceed against an outside party in the event that the guarantor is called upon to satisfy the guarantee. Examples include (a) guarantees of indebtedness of others, (b) obligations of commercial banks under “standby letters of credit,” and (c) guarantees to repurchase receivables (or, in some cases, to repurchase the related property) that have been sold or otherwise assigned. The Board concludes that disclosure of those loss contingencies, and others that in substance have the same characteristic, shall be continued. It says that "Standby Letters of Credit" are contingent liabilities, however, it seems like Standby Letters of Credit are more like contingent assets. If a bank holds a standby LoC, and the standby LoC is activated, then the bank will pay on behalf of the borrower. Then the bank will convert the amount it pays out into a loan, which the original party of the standby LoC will be obligated to pay back. This is my understanding. Does anybody know why FASB classifies standby LoC as contingent liabilities? Here is a link where I learned about Standby LoC:

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