As part of obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at the end of its 25-year useful life. 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. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network.
- In accountancy, contingent assets (i.e., holdings without liability) are one of the company’s standard types of financial instruments.
- Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity.
- 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.
- If a court is likely to rule in favor of the plaintiff, whether because there is strong evidence of wrongdoing or some other factor, the company should report a contingent liability equal to probable damages.
This potential asset will generally be disclosed in its financial statement, but not recorded as an asset until the lawsuit is settled. A contingent liability is a potential liability that may occur in the future, such as pending lawsuits or honoring product warranties. 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. A contingent asset is a potential economic benefit for an organization which does not accrue in reporting date but will accrue in future.
Contingent assets are assets that are likely to materialize if certain events arise. These assets are only recorded in financial statements’ footnotes as their value cannot be reasonably estimated. To avoid this, the accountant may be tempted to make some provisions for potential future expenses of $3m, with the impact of making the profit seem lower in the current year. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce profit to $10m.
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 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. Assuming that concern is facing a legal case from a rival firm for the infringement of a patent. In this example, the Developer will disclose 5 million as a contingent asset in the notes to accounts or board report (as applicable) till the court does not give its final verdict. This is because there is a probability of the Developer winning the case as there has been a violation of terms by the Authority. Although contingent liabilities are necessarily estimates, they only exist where it is probable that some amount of payment will be made.
What are the examples of contingent assets?
Likewise, it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. The main rule to follow is that where a single obligation is being measured, the best estimate will be the most likely outcome. 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. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. Before the introduction of IAS 37, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results that their various stakeholders wanted. Contingent assets are not recorded even if they are probable and the amount of gain can be estimated.
- This accrual account permits the firm to immediately post an expense without the need for a quick cash payment.
- For example, if the company is locked in a legal dispute and has the possibility of winning the case and being entitled to a claim or damages.
- The accounting rules ensure that the financial statement readers will receive sufficient information.
- Contingent assets are those assets which may or may not become a reality for a business depending on the outcome of a future event.
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 liabilities adversely impact a company’s assets and net profitability. A contingent asset is a potential asset or economic benefit for a company.
Revision Notes
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.
Accounting for Contingent Assets
Here in the notes about contingent assets, we are going to figure out some of the details that students need to know about in the chapter. A contingent liability is not recognized in the statement of financial position. adjusting journal entries However, unless the possibility of an outflow of economic resources is remote, a contingent liability is disclosed in the notes. A contingent liability is dependent on the outcome of an uncertain future event.
What is the debit entry?
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. EXAMPLE – expected value
Rey Co gives a year’s warranty with all goods sold during the year. Past experience shows that Rey Co needs to do no repairs on 85% of the goods.
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. (b) Past event
The obligation needs to have arisen from a past event, rather than simply something which may or may not arise in the future. 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.
EXAMPLE – best estimate
Rey Co has received legal advice that the most likely outcome of the court case from the employee is that they will lose the case and have to pay $10m. They believe there is a 10% chance of having to pay $12m, and a 10% chance of paying nothing. Only if the company wins the court case & gains from it, the contingent asset will actually be realized. There are certain cases or transactions when the final outcomes will not be known at that exact same time. Some examples of the incidents would include insurance claims, litigations, and pending disputes.
Usually, all GAAPs does not allow recording of contingent assets in books of accounts due to the principle of prudence or conservatism. Companies operating in the United States rely on the guidelines established in the generally accepted accounting principles (GAAP). Under GAAP, a contingent liability is defined as any potential future loss that depends on a “triggering event” to turn into an actual expense.
