Contingent Assets and Contingent Liabilities
IAS 37, details about the Provisions, Contingent Liabilities and about the Contingent Assets these outlines the accounting for the provisions (liabilities of uncertain timing or amount), (possible obligations and present obligations which are not probable or not reliably measurable)
Contingent Liabilities Meaning
A contingent liability is a specific type of liability, which may occur depending on the result of an uncertain future event. The contingent liability is then recorded if the contingency is likely the amount of the liability will be reasonably estimated by it. The contingent liability may be acknowledged in a footnote on the financial statements unless both the conditions are not met. The lawsuits which are pending and also the product warranties are the common contingent liability examples as their outcomes are not quite certain. The accounting rules for recording this contingent liability vary depending on the estimated dollar which amounts to the liability and is the likelihood of the event that is occurring. The accounting rules ensure that the financial statement readers will receive sufficient information.
Contingent Liabilities Example
Assuming that concern is facing a legal case from a rival firm for the infringement of a patent. The company would lose 3 million if they lose the case. The liability is both possible and easy to estimate thus, the firm posts an accounting entry on the balance sheet to debit that is to increase the legal expenses for 3 million and to credit that is to increase the accrued expense 3 million.
This accrual account permits the firm to immediately post an expense without the need for a quick cash payment. If they lose the case then the debit is applied to the accrued account and the cash is credited and is reduced to 3 million.
Contingent Assets Meaning
Contingent asset is a possible economic benefit thatA contingent is dependent on thatfuture events that are out of a company’s control. Without knowing for sure whether these gains will materialize, or will be able to determine their economic value, these assets are not to be recorded on the balance sheet. While, they can be noted down in the adjacent notes of the financial statements, provided that certain conditions are met well. A contingent asset can also be termed as a potential asset.
Contingent Assets Example
A company involved in a legal case with the sheer expectation to receive the compensation which has a contingent asset as the outcome of the case is not yet known and the amount is yet to be determined.
Company A Ltd. has filed a lawsuit against Company B Ltd. for infringing a patent case. If there is a good chance that Company A Ltd. will win the case, it has a contingent asset in this matter. This potential asset will generally be disclosed in the financial statement, but will not be recorded as an asset until the case is over and settled.
Contingent assets may also crop up when the companies expect to receive monetary awards through the use of their warranty. Other examples include the benefits that are to be received from an estate or other court settlement.
Contingent Liabilities in Balance Sheet
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.
A contingent liability is dependent on the outcome of an uncertain future event. A contingent liability is recorded in the records of accounting if the contingency is estimated in probability. Hence, a that future intent liability is recorded in the balance sheet as a form of a footnote.
Concept of Contingent Assets and Liabilities:
IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets.
Contingent Liabilities
Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity. An example is a litigation against the entity when it is uncertain whether the entity has committed an act of wrongdoing and when it is not probable that settlement will be needed. Contingent liabilities also include obligations that are not recognized because their amount cannot be measured reliably or because settlement is not probable. Contingent liabilities do not include provisions for which the entity certainly has a present obligation that is more likely than not to lead to an outflow of cash or other economic resources, even though the amount or timing is uncertain.
A contingent liability is not recognized in the statement of financial position. However, unless the possibility of an outflow of economic resources is remote, a contingent liability is disclosed in the notes.
Contingent Assets
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. Contingent assets are not recognized, but they are disclosed when it is more likely than not that an inflow of benefits will occur. However, when the inflow of benefits is virtually certain an asset is recognized in the statement of financial position because that asset is no longer considered to be contingent.
Examples of Contingent Liabilities:
The most common examples of Contingent Liabilities are given below –
Lawsuit
Product Warranty
Pending Investigation or Pending Cases
Bank Guarantee
Lawsuit for theft of Patent/know-how
Change of Government Policies
Change in Foreign Exchange
Liquidate Damages
FAQs on Contingent Assets vs. Contingent Liabilities
1. What is the main difference between a contingent asset and a contingent liability?
The key difference lies in the direction of potential economic flow. A contingent asset is a potential economic benefit (like money you might receive) that depends on a future event you can't control. A contingent liability is a potential economic obligation (like money you might have to pay) that also depends on an uncertain future event. Essentially, one is a potential gain, and the other is a potential loss.
2. Can you give some common examples of contingent liabilities?
Yes, some common examples of contingent liabilities for a business include:
- A pending lawsuit against the company where the outcome is uncertain.
- A product warranty offered to customers, as the company might have to pay for repairs in the future.
- A loan guarantee where the company has promised to pay if the original borrower defaults.
- Disputes over income tax or sales tax assessments that are yet to be settled.
3. What are some typical examples of contingent assets?
Contingent assets are less common, but a typical example is a lawsuit filed by the company against another party. If the company is likely to win and receive compensation, this is a contingent asset. Another example could be a claim for an insurance reimbursement that is currently under dispute but is probable to be received.
4. Why aren't contingent assets recorded in the main financial statements?
Contingent assets are not recorded due to the principle of conservatism or prudence in accounting. This principle states that you should not anticipate or record potential profits, but you should provide for all possible losses. Recording a contingent asset would mean recognising income that is not yet certain, which could be misleading to users of financial statements.
5. If a contingent liability isn't a confirmed debt, where is it shown in a company's reports?
A contingent liability is not recorded on the balance sheet as a standard liability. Instead, its existence is disclosed in the notes to the accounts that accompany the financial statements. This ensures transparency, informing investors and other stakeholders about a potential future obligation without overstating the company's actual liabilities.
6. How is a 'provision' different from a 'contingent liability'?
This is a common point of confusion. The main difference is the level of certainty.
- A provision is created when a liability is probable (likely to happen) and the amount can be reliably estimated. It is recorded in the balance sheet.
- A contingent liability is either not probable (only possible) or the amount cannot be reliably estimated. It is only disclosed in the notes, not recorded as a liability.
7. What happens when a contingent liability becomes a real, confirmed liability?
When the uncertain future event occurs and confirms the obligation (for example, the company loses the lawsuit), the contingent liability ceases to be 'contingent'. At that point, it becomes an actual liability. The company will then remove the disclosure from the notes and record the liability on its balance sheet and recognise the expense in the income statement.
8. Can the same event, like a legal dispute, be a contingent asset for one company and a contingent liability for another?
Yes, absolutely. In a legal dispute, the company that is suing (the plaintiff) has a contingent asset, as it might receive money if it wins. The company being sued (the defendant) has a contingent liability, as it might have to pay money if it loses. It's the same uncertain event viewed from two different financial perspectives.
