The accounting rules ensure that financial statement readers receive sufficient information. According to Accounting Standard 29, the contingent asset will not be disclosed while making the financial statements and that is due to the existence of the concept of prudence in accounting. However, when it comes to the approving authorities, they are allowed to make such mentions of the contingent liabilities and the contingent assets. However, the contingent asset disclosure can be made in the reports in the cases mentioned below.
This is effectively an attempt to move $3m profit from the current year into the next financial year. Contingent liabilities also include obligations that are not recognised because their amount cannot be measured reliably or because settlement is not probable. form 3800 instructions IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets. Companies operating in the United States rely on the guidelines established in the generally accepted accounting principles (GAAP).
When is a Contingent Asset Not Recognized as an Asset?
If the likelihood of resource inflow exceeds 50%, contingent assets are disclosed in the notes to financial statements (as per IAS 37.89) but aren’t recognised in the primary financial statements. If it becomes ‘virtually certain’ (roughly 90-95%, not explicitly defined in IAS 37) that resources will flow in, then the asset is recognised in the statement of financial position and profit or loss. Contingent liabilities are those that are likely to be realized if specific events occur. These liabilities are categorized as being likely to occur and estimable, likely to occur but not estimable, or not likely to occur. Generally accepted accounting principles (GAAP) require contingent liabilities that can be estimated and are more likely to occur to be recorded in a company’s financial statements. Contingent assets are an accounting tool used to account for uncertain future events.
- EXAMPLE
An employee was injured at work in 20X8 due to faulty equipment and is suing Rey Co. - After understanding the meaning of contingent assets, we are going to learn about the IAS 37 Provisions Contingent Liabilities And Contingent Assets.
- IAS stands for International Accounting Standard and according to that, there is a specific outline of the treatment provided to contingent liabilities and contingent assets too.
- Such an asset or economic interest arises from an uncertain and unpredictable event.
If, for example, the company forecasts that 200 seats must be replaced under warranty for $50, the firm posts a debit (increase) to warranty expense for $10,000 and a credit (increase) to accrued warranty liability for $10,000. At the end of the year, the accounts are adjusted for the actual warranty expense incurred. The accrual account permits the firm to immediately post an expense without the need for an immediate cash payment. If the lawsuit results in a loss, a debit is applied to the accrued account (deduction) and cash is credited (reduced) by $2 million.
Then that particular asset will not be considered as a contingent asset example. Contingent Assets are possible assets or potential economic benefits because they do not currently exist but may arise in the near future. The shift from possible assets to real assets for the entity is dependent on the occurrence or non-occurrence of future events which are not under its control. In accounting, contingent assets are recognised by the amount of cash generated from the event and removing it from accounts or providing the future cost of possible contingent liabilities on the balance sheet. If the uncertainty surrounding the existence of a contingent asset disappears, then the asset is no longer considered to be contingent and should be recognized in the financial statements. For example, if the company mentioned above wins its lawsuit, its proceeds would no longer be considered a contingent asset.
Consequently, the provision will increase each year until it becomes $20m at the end of the asset’s 25-year useful life. EXAMPLE
Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. As part of obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at the end of its 25-year useful life.
Contingent Assets Meaning
Rey Co’s lawyers have advised that it is probable that the entity will be found liable. Rey Co would have to provide for the best estimate of any damages payable to the employee. This is because the event arose in 20X8 and, based on the evidence available, there is a present obligation. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network.
Contingent Assets in Accounting: Everything You Need to Know
Contingent assets are assets dependent on non-operating assets’ performance. For example, a tract of land used for farming could be classified as a contingent asset. If the crops are good, the value will increase; it will decrease if they’re not good. Contingent assets often depend on how other companies perform in a particular sector or industry. For example, gold prospectors have contingent assets in accountancy until their claims are proven and validated.
A contingent asset is a potential asset that may become an actual asset depending on future events. In other words, it’s an asset that is not currently recognized because it’s not confident that the asset will be realized. Contingent assets also crop up when companies expect to receive money through the use of a warranty. Other examples include benefits to be received from an estate or other court settlement. Anticipated mergers and acquisitions are to be disclosed in the financial statements. Let’s say Company ABC has filed a lawsuit against Company XYZ for infringing a patent.
What Is Important to Know About Contingent Liability?
A contingent liability is a liability that may occur depending on the outcome of an uncertain future event. A contingent liability has to be recorded if the contingency is likely and the amount of the liability can be reasonably estimated. Both generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) require companies to record contingent liabilities.
The ‘not-to-prejudice‘ exemption in IAS 37.92 also extends to contingent assets. Additionally, see the forum’s discussion regarding a scenario where a once-recognised contingent asset’s likelihood of resource inflow is no longer virtually certain. A provision is measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. In these notes for contingent assets and liabilities, we are going to discuss both of these topics so that students can have an idea about the chapter and can score good marks in the examinations.
Under GAAP, a contingent liability is defined as any potential future loss that depends on a “triggering event” to turn into an actual expense. Contingent assets are assets that are likely to materialize if certain events arise. These assets are only recorded in financial statements’ footnotes as their value cannot be reasonably estimated. The materiality principle states that all important financial information and matters need to be disclosed in the financial statements. An item is considered material if the knowledge of it could change the economic decision of users of the company’s financial statements.
Similar to the concept of a contingent liability is the concept of a contingent asset. A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. Again, a description of the event should be recorded in addition to any potential amount. The key difference is that a contingent asset is only disclosed if there is a probable future inflow, rather than a possible one. The table below shows the treatment for an entity depending on the likelihood of an item happening.
Definition of contingent liability
This will be disclosed in the notes to the financial statements rather than being recorded as an asset in the statement of financial position. Whilst this seems inconsistent, this demonstrates the asymmetry of prudence in this standard, that losses will be recorded earlier than potential gains. For example, if a company is facing a legal dispute where there are huge chances of favourable outcome whereby it will claim the amount for damages or anticipate a merger and be paid on account of warranty. These will be considered as the contingent asset of a company and will not be recorded in books of accounts buy will be disclosed under the Notes to Accounts followed by financial statements. A contingent asset may be disclosed as a footnote to the balance sheet, These are not recognized in financial statements since this may result in recognition of income that may never be realized.
Usually, all GAAPs does not allow recording of contingent assets in books of accounts due to the principle of prudence or conservatism. An entity recognises a provision if it is probable that an outflow of cash or other economic resources will be required to settle the provision. If an outflow is not probable, the item is treated as a contingent liability. Unlike contingent assets, they refer to a potential loss that may be incurred, depending on how a certain future event unfolds.
