If the liability is likely to occur and the amount can be reasonably estimated, the liability should be recorded in the accounting records of a firm. The word contingent or contingency means “possible, but not certain to occur”. Contingent assets are those assets which may or may not become a reality for a business depending on the outcome of a future event. The existence of this kind of asset is completely dependent on the occurrence of a probable event in future. Contingent assets are ruled under the conservatism principle, which is an accounting practice that states that uncertain events and outcomes should be reported in a manner that results in the lowest potential profit.

  • EXAMPLE
    An employee was injured at work in 20X8 due to faulty equipment and is suing Rey Co.
  • On the other hand, if it is only reasonably possible that the contingent liability will become a real liability, then a note to the financial statements is required.
  • Reasonably possible losses are only described in the notes and remote contingencies can be omitted entirely from financial statements.
  • It can be seen here that Rey Co could only recognise an asset from a potential inflow if the realisation of income is virtually certain.
  • IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets.
  • In the scenario discussed by the IFRS Interpretations Committee, an entity, confident about winning a dispute with tax authorities, pays the disputed amount as a deposit to avert penalties if it loses.

EXAMPLE
At 31 December 20X8, the legal advisors of Rey Co now believe that the $10m payment from the court case would be payable in one year. Similarly, Rey Co would not provide for any possible claims which may arise from injuries in the future. That is because there is no past event which has created an obligation and any possible claims could be avoided by implementing new safety measures or selling the factory. Even if the country that Rey Co operates in has no legal regulations forcing them to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history.

FAQs on Contingent Assets and Liabilities

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. An example is 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. For U.S. GAAP, there generally needs to be a 70% likelihood that the gain occurs.

  • Contingent convertibles work in a fashion similar to traditional convertible bonds.
  • 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.
  • However, IAS 37 is often a key standard in FR exams and candidates must be prepared to demonstrate application of the criteria.
  • Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity.
  • In addition to this, the discount on the provision will be unwound and debited to finance costs.

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. Here, Rey Co would capitalise the $170m as part of property, plant and equipment. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. In addition to this, the discount on the provision will be unwound and debited to finance costs. Consequently, the provision will increase each year until it becomes $20m at the end of the asset’s 25-year useful life.

Contingent liabilities are recorded if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements unless both conditions are not met. Contingent assets, tied to uncertain future events, demand prudent accounting. Premature recognition risks distorting financial statements and potentially misleading stakeholders.

About the IFRS Foundation

In the scenario discussed by the IFRS Interpretations Committee, an entity, confident about winning a dispute with tax authorities, pays the disputed amount as a deposit to avert penalties if it loses. Upon resolution, the deposit will either be refunded to the entity (if it wins) or offset against the obligation (if it loses). The Committee concluded that this deposit constitutes an asset, and the entity isn’t required to be virtually certain of a favourable outcome to recognise it (as opposed to expensing this amount). The deposit ensures future economic benefits, either through a cash refund or settling the liability. Nonetheless, this agenda decision shouldn’t be generalised to regular legal proceedings where, facing an adverse verdict, an entity doesn’t retain any assets. In such instances, the ‘virtually certain’ threshold is applicable before a disputed asset can be recognised.

International Reserves/Foreign Currency Liquidity (as of the end of December

This rule has two parts, first the type of obligation, and second, the requirement for it to arise from a past event (ie something must already have happened to create the obligation). That standard replaced parts of IAS 10 Contingencies and Events Occurring after the Balance Sheet Date that was issued in 1978 and that dealt with contingencies. IFRS Sustainability Standards are developed to enhance investor-company dialogue so that investors receive decision-useful, globally comparable sustainability-related disclosures that meet their information needs. Contingent convertibles act as additional Tier 1 capital allowing European banks to meet the Basel III requirements. These convertible debt vehicles allow a bank to absorb the loss of underwriting bad loans or other financial industry stress. Contingent asset accounting policies for GAAP, meanwhile, are mainly outlined in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 450.

Amendments under consideration by the IASB

Therefore, one should carefully read the notes to the financial statements before investing or loaning money to a company. Contingent liabilities, liabilities that depend on the outcome of an uncertain event, must pass two thresholds before they can be reported in financial statements. If the value can be estimated, the liability must have greater than a 50% chance of being realized. So, if it is probable the settlement of the contingency will result in a gain, the entity should probably go ahead and record that gain on the income statement, right? The only time a contingent asset can be recognized in the statement of financial position is when it is VIRTUALLY CERTAIN that the inflow of benefits will happen.

Contingent liabilities are not recognised, but are disclosed unless the possibility of an outflow of economic resources is remote. Onerous contracts
Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. As soon as an entity is aware that a contract is onerous, the full loss should be provided for as a liability in the statement of financial position. 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. 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.

Examples of contingencies are home inspections, attorney review, the buyer’s financing, appraisal, and title search, among other reasons. Other foreign currency assets include loans to The Japan Bank for International Cooperation (JBIC) in total of $ 41,226 million. If the entity can estimate a range, and no single amount within that range represents the best estimate (in other words, each amount is equally likely to occur), the midpoint of that range should be accrued.

This is the escrow period, when both buyer and seller are working toward a closing. Even though a sale is highly likely, some pending properties what’s the difference between book value vs. market value may still accept backups. If your offer is accepted as a backup, you’re in line to go under contract if the first sale falls through.

The legal advisors believe that there is an 80% chance that the counter claim against the manufacturer is likely to succeed and believe that Rey Co would win $8m. 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. This is because the event arose in 20X8 and, based on the evidence available, there is a present obligation. For some ACCA candidates, specific IFRS® standards are more favoured than others.