Guarantees

A guarantee is normally a right to proceed against an outside party (a guarantor).¹ Guarantor companies contract to indemnify other companies against certain contingent losses in the event that they arise. A guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur.²

Guarantees typically have a remote possibility of loss and, according to FASB Statement No. 5, should nonetheless be disclosed in the notes. On the contrary, FASB Interpretation No. 45 tells us that guarantees must be initially recognized on the financial statements as a liability even if they do not meet the criteria required for recognizing contingent liabilities. The fair value of the guarantee should be the price that the guarantee would be sold for on an active market.

Reference:

1. FASB Statement No. 5
2. Summary of Interpretation No. 45. Retrieved from: http://www.fasb.org/summary/finsum45.shtml.
3. FASB Interpretation Bulletin No. 45

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