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)
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 varies depending on the estimated dollar which amounts of the liability and is likelihood of the event that is occurring. The accounting rules ensure that the financial statement readers will receive sufficient information.
Assuming that a 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 debit is applied to the accrued account and the cash is credited and is reduced 3 million.
Contingent asset is a possible economic benefit which is dependent on the future 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 the certain conditions are met well. A contingent asset can also be termed as a potential asset.
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 its warranty. Other examples include the benefits that are to be received from an estate or other court settlement.
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 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, contingent liability is recorded in the balance sheet as a form of a footnote.
1. What is the Objective of IAS 37?
Ans. The objective of IAS 37 is to ensure that adequate recognition criteria and measurement bases are accurately applied to the provisions, contingent liabilities and the contingent assets and that necessary information is disclosed in the notes to the financial statements which would enable the users to understand their nature, timing and the amount.
IAS 37 defines and also specifies the accounting for and disclosure of the provisions, of all the contingent liabilities, and all the contingent assets. A provision here is described as a liability of uncertain timing or amount. The liability which may be a legal obligation or of a constructive obligation.
2. What Do you Mean by Product Warranties?
Ans. A warranty is a guarantee that the manufacturer or similar party to a manufacturer will make good the condition of its product. This also refers to the terms and the situations in which the repairs or the exchanges will be made in the event that the product will not function as originally described or as intended.
A warranty is actually “a promise or a guarantee that is given.” A warranty is generally a written statement.
3. What is Patent?
Ans. A patent is a right exclusively granted for an invention. Patent protection means that the invention cannot be commercially produced, used, or distributed, neither imported, or sold by others without the patent owner's consent or permission.