Updated July 19, 2023
Introduction to Contingent Asset
Contingent asset can be defined as a potential economic resource which will accrue or arise to the organization as a result of past event and existence can be confirmed only on the occurrence or non-occurrence of a future uncertain event which is not entirely within the control of the entity.
A contingent asset is a potential economic benefit for an organization which does not accrue in reporting date but will accrue in future. The event of a contingent asset depends totally on occurrence or non-occurrence of a particular set of things which are even beyond the control of the company and are unpredictable or uncertain.
As accounting follows conservatism concept which provides for all possible liabilities but defers accounting of possible asset i.e. any benefit that may arise in future, it does not allow recording of a contingent asset or gains arising out until they get accrued. For example, if a company is facing a legal dispute where there are huge chances of favourable outcome whereby it will claim the amount for damages or anticipate a merger and be paid on account of warranty. These will be considered as the contingent asset of a company and will not be recorded in books of accounts buy will be disclosed under the Notes to Accounts followed by financial statements.
How Does It Work?
Contingent assets are economic resources or benefits which gets are not readily realisable or accrued but gets accrued on a future date on the occurrence of an uncertain event. When the occurrence of the contingent asset becomes certain and it gets accrued, then only it is treated as a realized asset of economic value and can be recorded in books of accounts and reported in Balance Sheet with its cash flow. Being an asset, it can be recorded only once the asset gets accrued. Contingent asset occurs when the economic value of an asset is unknown also it may occur when the outcome of an event becomes certain and where an asset is created.
Usually, all GAAPs does not allow recording of contingent assets in books of accounts due to the principle of prudence or conservatism. According to this principle, one should not mis-state its balance sheet by overstating of income/ expenses or asset/ liabilities and provide for all possible expenses and liabilities but defer accounting of all possible income and assets until they get accrued.
Examples of Contingent Assets
- Marc Inc. an electronics home appliance manufacturing company was facing a lawsuit regarding a disputed immovable property (Land)since 1998 which is about to close as Apex court in its next hearing scheduled on 21/01/2020 most probably, the court will issue a decision in favour of company and ownership of land will get transferred in favour of the company. Now, as on reporting date say 31/12/2019, Mark Inc. will treat this land as a contingent asset but cannot record this in books of accounts. However, it will disclose this land under notes to accounts of financial statements.
- Henry Inc. entered into a contract for the purchase of thread with one vendor. It was one of the term of the contract that vendor will supply thread at a reduced price once after threshold limit is reached. But later on, the vendor denied to supply thread as reduced price. Henry Inc. has filed a suit against its vendor for non-compliance of its agreed term. Apex court is about to pronounce decision in favour of Henry Inc. on 22/02/2020. Therefore, now on 31/12/2019 Henry Inc. will treat the amount of claim i.e. discount on the thread as a potential asset i.e. contingent asset. Since the decision is not yet pronounced, the discount does not gets accrued as on 31/12/2019 and therefore Henry Inc. cannot treat this as an asset as on date. However, once a decision is pronounced, it can record and report this as an asset.
Where Contingent Assets are Recorded
As per generally accepted accounting principle(GAAP), every contingent asset needs to be disclosed under the Notes to Accounts under the financial statement. Whereas another reporting standard International Financial Reporting Standards IFRS does not make it necessary for the company to report a contingent asset. International accounting standard IAS 37 that applies to IFRS states that contingent assets should not be recognised but shall be disclosed when it is most likely that benefits will occur however when the benefit inflow is certain an asset is not considered contingent.
Contingent asset accounting policies according to GAAP are outlined in the financial accounting standard board. Contingent assets need to be closely monitored. Probable and quantifiable gains are not included in financial statements but can be disclosed in the notes if they are material. The concept of materiality states that if a contingency gain is unrealized and affects the decision of the users it should be disclosed in notes.
Advantages
Some of the advantages are:
- It is a possible asset that arises due to past events.
- It is only disclosed when the inflow of economic benefit for the enterprise is confirmed and certain.
- It is a possible gain to an enterprise with respect to future events that are not in control of the enterprise.
- Contingent asset remains no longer an asset on the realization of the benefit and gets transferred to the actual and real asset that is to be represented in the balance sheet.
Conclusion
Contingent assets are those possible assets whose existence are confirmed only upon the occurrence or non-occurrence of future events that are uncertain and not completely within the control of the enterprise. These assets are disclosed and not recognised when the inflow of benefit is likely to occur. Auditors keep a keen watch over a contingent asset that is reported in financial statement records and make suitable suggestions to eliminate these records before issuing an opinion on its financial statement. Contingent liability must be recognised prior to contingent assets.
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