Off-balance-sheet and contingent liabilities, explained simply
A guarantee given for someone else’s loan, a pending claim or accumulating warranty costs may not appear in the numbers, yet any may become a real payment.
Diligence reviews contracts, legal letters, board minutes, bank confirmations and payments after the period end, and asks management directly. Findings are priced, indemnified, escrowed or resolved as a condition to closing.
ASC 450 treatment of contingencies
IllustrativeWith examples from Alder Creek Manufacturing
Each of the three examples requires a different response in the purchase agreement.
Worked example
- Mortgage guarantee: the company guarantees a $3.0 million mortgage of the owner’s property company. The guarantee must be released at closing.
- Warranty claims: these doubled in 2026 and there is no warranty reserve. Diligence estimates $0.2 million of future claims.
- Former employee claim: worth up to $0.3 million, with lawyers rating the outcome “reasonably possible”. The buyer asks for a specific indemnity.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
How buyers respond
- Price reduction or treatment as a debt-like item
- Specific indemnity in the purchase agreement
- Escrow or holdback
- Release of guarantees as a condition to closing
Why it matters in a deal
These items are invisible in the financial statements but real after closing. Finding them is among the most valuable things diligence does.
Red flags
- Legal letters or demand notices in correspondence
- Guarantees given for the owner’s other businesses
- Warranty costs rising with no reserve
Frequently asked questions
What are off-balance-sheet and contingent liabilities in M&A?
Off-balance-sheet liabilities are obligations not recorded on a company’s balance sheet. Contingent liabilities are possible obligations that depend on a future event, such as the outcome of a lawsuit. Diligence looks for both because they can cost the buyer money after closing.
How does diligence find off-balance-sheet items?
By reviewing contracts, legal letters, board minutes, bank confirmations and post-period payments, and by asking management.
Are all contingencies deducted from the price?
No. Many are handled through indemnities or escrow.