Bonds and guarantees: exposure and disclosure

Bank guarantees issued on the contractor's behalf are contingent exposures disclosed rather than recognized until a call becomes probable, at which point a provision, and often a dispute, crystallizes suddenly; the margin deposits backing these facilities are restricted cash that is frequently and wrongly presented as free liquidity. In a downturn, bond-call waves can hit multiple projects simultaneously, so the aggregate portfolio, not just individual instruments, represents a material tail risk to solvency.

What is the full portfolio of outstanding bonds and guarantees by project, bank, and expiry, and are any on-demand? Is call probability assessed based on the client relationship and dispute/termination signals, not just contractual fault? Once a call becomes probable and estimable, is a provision recognized rather than continuing to treat it as a mere contingent disclosure? Is cash margin collateral backing the bonding facility presented as restricted cash, separate from the guarantee provision and from unrestricted liquidity?

1) Inventory the full portfolio of outstanding bonds/guarantees issued on the contractor's behalf (bid bonds, advance payment guarantees, performance bonds, retention bonds) by project, bank, expiry, and whether on-demand or conditional. 2) For each instrument, assess whether a call is probable, not merely possible, on-demand bonds can be called by the beneficiary regardless of contractual merit, so assess call risk based on the client relationship, dispute status, and termination signals, not just who is contractually 'at fault'. 3) Where a call is not probable, treat the guarantee as a contingent liability: disclose but do not recognize a provision. 4) Where a call becomes probable and the amount can be reliably estimated, recognize a provision for the expected outflow (IAS 37), reduced by any amount already reflected elsewhere (e.g. a related onerous contract provision) to avoid double counting. 5) If a bond is actually called, recognize the cash outflow/liability to the bank when the call is honored, and separately assess whether the entity has a contractual or legal right to recover the amount from the counterparty (e.g. via arbitration), recognize that recovery as a contingent asset (disclosed only) unless recovery is virtually certain. 6) Track cash margin deposits placed with banks to secure the bonding facility as restricted cash (see the related escrow/restricted-cash issue), separate from the guarantee/provision accounting itself.

Contingent liabilities (calls assessed as merely possible, not probable) are not recognized but are measured for disclosure purposes at the maximum exposure under the outstanding instruments. Once a call is assessed as probable, the provision is measured at the best estimate of the expenditure required to settle the obligation at the reporting date, typically the face amount likely to be called, adjusted for any partial-call history or negotiated settlement expectations, discounted only if the time value of money is material (unusual given calls are typically near-term once probable). Margin/cash collateral held by the bank against the bonding line is a financial asset (restricted cash or a deposit) measured at its deposit value; it is not netted against the contingent liability or provision, since the developer/contractor's exposure (the guarantee) and its own asset (the collateral) are usually not subject to a legal right of set-off with the beneficiary. Subsequent measurement: reassess call probability every reporting period as project status, disputes, and termination risk evolve; on settlement of a called bond, remeasure any recovery asset based on updated legal/arbitration progress, recognizing it only when recovery becomes virtually certain.

Disclose the total outstanding guarantee/bond portfolio by type (bid, advance payment, performance, retention bonds) and, where material, by major project or counterparty bank; disclose restricted cash margins/collateral backing the bonding facilities, cross-referenced to the restricted cash note; disclose any bonds called during the period, amounts paid, and the status of any recovery claim pursued against the counterparty; disclose the nature of unrecognized contingent liabilities and, where practicable, an estimate of their financial effect, per IAS 37; disclose significant judgments in assessing call probability, especially where termination notices or disputes exist.

• Ignoring the guarantee portfolio entirely in disclosures until a call actually happens, leaving users blind to a material contingent exposure
• presenting cash margin deposits backing bonds as unrestricted, freely available cash in liquidity disclosures
• assessing call probability purely on contractual entitlement/fault rather than the practical reality that on-demand bonds can be called regardless of merit
• silently netting an expected counterclaim or recovery against a recognized bond-call provision instead of showing both the provision and any virtually-certain recovery asset separately
• failing to reassess call probability as a project deteriorates (e.g. after a termination notice), so the provision is recognized too late, after the call has already happened.