Performance, advance-payment and retention bonds and guarantees

Performance bonds, advance-payment guarantees and retention bonds are off-balance-sheet contingent exposures until a call becomes probable, and the common failure mode is either recognizing a liability too early on a merely possible (not probable) call, understating the entity's genuine exposure by treating the bond purely as a disclosure item once a call becomes probable, or failing to distinguish the bond itself from the cash margin/blocked deposit the bank may hold as security, which is the entity's own asset.

Is there a specific indication, such as a formal default notice or a disputed completion, that makes a call on a performance or advance-payment bond probable rather than merely possible? Is cash pledged or blocked with the issuing bank as security for a guarantee, requiring restricted-cash disclosure rather than presentation as unrestricted cash and cash equivalents? If a call is probable, is the provision measured at the specific amount the employer is entitled to draw for the actual breach, rather than defaulting to the bond's full face value? Are bond commission and issuance costs expensed systematically over the guarantee coverage period rather than in full at inception?

1. Classify the instrument: a performance bond, advance payment guarantee or retention bond issued by a bank on the contractor's behalf is a contingent liability of the contractor (to reimburse the bank if called), do not recognize a liability merely because the bond exists.
2. Recognize a provision only when a call on the bond becomes probable (more likely than not) and the amount can be reliably estimated, based on the same recognition threshold as any other IAS 37 provision (e.g. probable non-performance, probable delay triggering an advance-payment guarantee call).
3. Where a bond call is assessed as reasonably possible but not probable, disclose it as a contingent liability rather than recognizing a provision.
4. Separately recognize any cash margin, blocked deposit or restricted bank balance the entity has pledged to the issuing bank as security for the bond as the entity's own financial asset (typically restricted cash), regardless of whether a call is probable.
5. If a call is made and paid, derecognize the provision (if one was recognized) and recognize the actual cash outflow or a receivable/right of pursuit against a defaulting subcontractor if back-to-back security exists.

Measure any provision for a probable bond call at the best estimate of the amount the employer is entitled to draw, based on the specific default or breach giving rise to the call, not the full face value of the bond by default. Measure cash margins or blocked deposits securing bonds at their carrying amount (typically cost, being the cash pledged) and disclose any restriction on use; where such deposits earn interest, recognize interest income under the applicable financial instrument measurement basis.

Disclose: (1) the nature and amount of outstanding bonds and guarantees issued on the entity's behalf, distinguishing performance, advance-payment and retention bonds; (2) any provisions recognized for probable calls, separately from contingent liabilities for possible-but-not-probable calls; (3) cash margins or blocked deposits pledged as security, including any restriction on use, presented separately from unrestricted cash; (4) the entity's assessment methodology for probability of a call.

• Recognizing a provision for the full face value of a performance bond as soon as a project encounters difficulty, without a probable-call assessment specific to the actual breach
• treating a cash margin or blocked deposit securing a bond as if it were unrestricted cash, overstating available liquidity
• failing to disclose material outstanding bond exposure as a contingent liability when a call is reasonably possible but not yet probable
• not distinguishing between the contractor'
• s own contingent exposure and any back-to-back security or counter-guarantee obtained from a subcontractor, leading to an incomplete net exposure picture.