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. In a similar way Accounting Standard 29 was made by ICAI to deal with such treatment details. Contingent liabilities are not recognised, but are disclosed unless the possibility of an outflow of economic resources is remote. Future operating losses
Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. The final criteria required is that there needs to be a probable outflow of economic resources.
- Let’s explore a practical scenario involving a company embroiled in a legal dispute.
- Not knowing for certain whether these gains will materialize, or being able to determine their precise economic value, means these assets cannot be recorded on the balance sheet.
- However, the nature of the event is required to be disclosed in the footnotes to the financial statements.
- These assets are disclosed and not recognised when the inflow of benefit is likely to occur.
- Doing so at least reveals the presence of a possible asset to the readers of the financial statements.
Thus, extensive information about commitments is included in the notes to financial statements but no amounts are reported on either the income statement or the balance sheet. Unlike loss contingencies, gain contingencies are not recorded in the financial statements, no matter how certain they appear. This is due to the accounting principle of conservatism, which requires that revenues are only recorded when realized and expenses are recorded when probable. A subjective assessment of the probability of an unfavorable outcome is required to properly account for most contingences. Rules specify that contingent liabilities should be recorded in the accounts when it is probable that the future event will occur and the amount of the liability can be reasonably estimated. This means that a loss would be recorded (debit) and a liability established (credit) in advance of the settlement.
If the provision being measured involves a large number of items, such as a warranty provision for repairing goods, the expected value should be calculated using the probability of all possible outcomes. EXAMPLE
An employee was injured at work in 20X8 due to faulty equipment and is suing Rey Co. 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.
IAS 37 — Changes in decommissioning, restoration, and similar liabilities
This is because the event arose in 20X8 and, based on the evidence available, there is a present obligation. Contingent assets are not recorded even if they are probable and the amount of gain can be estimated. IFRS Accounting Standards are, in effect, a global accounting language—companies in more than 140 jurisdictions are required to use them when reporting on their financial health.
Contingencies are potential liabilities that might result because of a past event. Loss contingencies are recognized when their likelihood is probable and this loss is subject to a reasonable estimation. Reasonably possible losses are only described in the notes and remote contingencies can be omitted entirely from financial statements.
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With our notes, students can have all the details that they want to have in the first place. With help of our notes, students can know the meaning of contingent assets in the best way. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. EXAMPLE – Likelihood
Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m.
Contingent Assets and Contingent Liabilities (IAS
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. Based on this same example, Company XYZ would need to disclose a potential contingent liability in its notes and then later record it in its accounts, should it lose the lawsuit and be ordered to pay damages. A company involved in a lawsuit that expects to receive compensation has a contingent asset because the outcome of the case is not yet known and the dollar amount is yet to be determined. The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. Contingent assets are possible assets whose existence will be confirmed by the occurrence or non-occurrence of uncertain future events that are not wholly within the control of the entity.
What Is a Contingent Asset?
Conversely, the other party that is probably going to lose the lawsuit must record a provision for the contingent liability as soon as the loss becomes probable, and should not wait until the lawsuit has been settled to do so. Thus, recognition of the contingent liability comes before recognition of the contingent asset. Several financial statements tend to follow certain accounting concepts and principles. However, there are some cases where relevant and important information is not present in some of the statements and that is due to some of these accounting principles and concepts.
Clearly this is not good for the users of the financial statements, as they would have been given a false impression of the performance of the business. This is where IAS 37 is used to ensure that companies report only those provisions that meet certain criteria. This example illustrates how a contingent asset evolves from uncertainty to recognition based on confirming a specific triggering event, in this case, a favorable legal outcome. A contingent liability is recorded as an ‘expense’ in the Profit & Loss Account and then on the liabilities side of the financial statement, that is the Balance sheet.
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The accountant knows that if Rey Co reports a profit of $13m, directors will not get any more of a bonus than if they reported $10m. For some ACCA candidates, specific IFRS® standards are more favoured than others. However, IAS 37 is often a key standard in FR exams and candidates must be prepared to demonstrate application of the criteria. PwC leasing vs financing refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. The ‘not-to-prejudice‘ exemption in IAS 37.92 is also applicable to contingent liabilities.
