Capital & Contingent Liability - Verification and Valuation of Assets and Liabilities | Auditing and Secretarial Practice - B Com PDF Download

Capital – What is capital?

Capital can include cash or other assets introduced into a business by the owners

Generally speaking, the term ‘capital’ refers to any financial resources or assets owned by a business that are useful in furthering development and generating income.

However, in different contexts, the term can have a variety of other meanings.

Here are a few:

• Capital can refer to funds raised to support a particular business or project.
• Capital can also represent the accumulated wealth of a business, represented by its assets less liabilities.
• Capital can also mean stock or ownership in a company.

How it differs from money

While it may seem that the term capital is almost the same as money, there is an important difference between the two. Money is used for the purchase and sale of goods or services within a company or between two companies or individuals and therefore has a more immediate purpose.

Capital, however, also includes assets such as investments, stocks, and other assets that are more long-term and could benefit the company in the future. Capital involves the aspects of a company that help build and improve it, that form its base for generating revenues.

Associated terms

Other terms that relate to capital include:

• Capital gains: increases in the value of stock and other assets when they are sold.
• Capital structure: the mix of debt and equity in the business balance sheet.
• Capital improvements: improvements made to capital assets.

Tax on capital

Because capital is owned by a company, it is protected. However, capital ownership can be transferred or sold and, in certain situations, faces tax.

Capital that has appreciated in value over the course of a company’s ownership from time of purchase to time of sale (capital gains), could be liable to tax. These taxed amounts go to the public benefit.

Contingent liability

A contingent liability is either a possible obligation arising from past events and depending on future events not under an entity's control, or a present obligation not recognized because either the entity cannot measure the obligation or settlement is not probable. You do not recognize a contingent liability. Instead, only disclose the existence of the contingent liability, unless the possibility of payment is remote.

There are three possible scenarios for contingent liabilities, all of which involve different accounting transactions. They are:

• Recordation. Record a contingent liability when it is probable that a loss will occur, and you can reasonably estimate the amount of the loss. If you can only estimate a range of possible amounts, then record that amount in the range that appears to be a better estimate than any other amount; if no amount is better, then record the lowest amount in the range. “Probable” means that the future event is likely to occur. You should also describe the liability in the footnotes that accompany the financial statements.
• Disclosure. Disclose the existence of a contingent liability in the notes accompanying the financial statements if the liability is reasonably possible but not probable, or if the liability is probable, but you cannot estimate the amount. “Reasonably possible” means that the chance of the event occurring is more than remote but less than likely.
• No treatment. Do not record or disclose a contingent liability if the probability of its occurrence is remote.

Examples of contingent liabilities are: 

•  The outcome of a lawsuit
• A government investigation
• The threat of expropriation

A warranty can also be considered a contingent liability.