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CMA Final · Strategic Performance Management and Business Valuation · Valuation of Assets and Liabilities

Which of the following is the correct approach when valuing a contingent liability for a business valuation exercise, where an outflow is possible but not probable and cannot be measured reliably?

A contingent liability that is possible but not probable and cannot be measured reliably should not be booked as a firm liability. The valuer discloses it and assesses its potential effect through scenario or sensitivity analysis, instead of ignoring it or deducting the full amount.

  1. AProvide the full estimated amount as a liability in the valuation
  2. BIgnore it completely, since contingent liabilities never affect value
  3. CTreat it as a deduction equal to the entity's total net worth
  4. DDisclose it and consider its likely impact through scenario or sensitivity analysis rather than recognising a firm liabilityCorrect

Explanation

A possible but non-probable and non-measurable obligation is not recognised as a firm liability. A valuer disclosures and reflects the risk through scenarios or sensitivities. Full provision overstates the liability, while ignoring it hides a risk.

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