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 and Liabilities
1. What is the objective of IAS 37?
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 may be a legal obligation or a constructive obligation.
2. What do you mean by Product Warranties?
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 if 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 a patent?
A patent is a right exclusively granted for an invention. Patent protection means that the invention cannot be commercially produced, used, or distributed, either imported or sold by others without the patent owner's consent or permission.
4. What are the reporting requirements of contingent liabilities?
Contingent liabilities means liabilities that depend on the outcome of an uncertain event must pass two thresholds before they can be reported in financial statements. First, it must be possible to estimate the value of the contingent liability. If the value can be estimated, the liability must have a greater than a 50% chance of being realized. Qualifying contingent liabilities are recorded as an expense on the income statement and a liability on the balance sheet. If the contingent loss is remote, meaning it has less than a 50% chance of occurring, the liability should not be reflected on the balance sheet. Any contingent liabilities that are questionable before their value can be determined should be disclosed in the footnotes to the financial statements.
5. What are the rules in recording a contingent asset and contingent liability?
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 liability established (credit) in advance of the settlement. Whereas, a contingent asset becomes a realized asset recordable on the balance sheet when the realization of cash flows associated with it becomes relatively certain. In this case, the asset is recognized in the period when the change in status occurs. Contingent assets may arise due to the economic value being unknown.
6. How do you disclose contingent assets and liability?
A contingent asset is not disclosed in the financial statements. It is usually disclosed in the report of the approving authority (Board of Directors in the case of a company, and, the corresponding approving authority in the case of any other enterprise), where an inflow of economic benefits is probable. On the other hand; one can disclose the existence of a contingent liability in the notes accompanying the financial statements if the liability is reasonably possible but not probable, or if the liability is probable, but you cannot estimate the amount.
7. What is the journal entry for contingent liabilities?
The Company can make contingent liability journal entries by debiting the expense account and crediting the contingent liability account. This journal entry is to show that when there is a probability of future cost which can be reasonably estimated, the company needs to recognize and record it as an expense immediately.
8. How do you record a contingent asset?
A contingent asset becomes a realized asset recordable on the balance sheet when the realization of cash flows associated with it becomes relatively certain. In this case, the asset is recognized in the period when the change in status occurs. Contingent assets may arise due to the economic value being unknown.