Contingent Liability: What Is It, and What Are Some Examples?

It’ll be measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period (or to transfer it to a third party). This estimate includes considering risks and uncertainties related to the timing and amount of payment as well as the time value of money. Not only that, but the estimate should be updated each and every reporting period to reflect the current best estimate. The treatment of a contingent asset is not consistent with the treatment of a contingent liability, which should be recorded when it is probable (thereby preserving the conservative nature of the financial statements). This means that contingent liabilities are more likely to be recorded than contingent assets. If the chance of the future event occurring is less than likely, but more than remote, GAAP calls the event reasonably possible.

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. 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 accumulated depreciation and depreciation expense by companies trying to ‘smooth profits’ in order to achieve the results that their various stakeholders wanted. Contingent assets should be regularly assessed to ensure that they are properly disclosed in the financial statements. In addition, the disclosure should include the most probable loss amount, or if that number cannot be determined, a range of possible loss.

II. Predetermined short-term net drains on foreign currency assets

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. The ICAEW Library & Information Service provides full text access to a selection of key business and reference eBooks from leading publishers. EBooks are available to logged-in ICAEW members, ACA students and other entitled users. If you are unable to access an eBook, please see our Help and support advice or contact Keep up-to-date on the latest insights and updates from the GAAP Dynamics’ team on all things accounting and auditing.

  • This is because the event arose in 20X8 and, based on the evidence available, there is a present obligation.
  • The amount of the provision should be the best estimate of the amount required to settle the obligation at the reporting date.
  • Overviews of each international accounting standard, with a history and timeline of key events and amendments.
  • Entities often make commitments that are future obligations that do not yet qualify as liabilities that must be reported.

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. (a) Type of obligation
The obligation could be a legal one, arising from a court case or some kind of contractual arrangement. Most candidates are able to spot this in exams, identifying the presence of a potential obligation of this type.

While making the entry, a debit to an expense account and a credit to a liability account is easy, determining whether the loss is probable is the difficult part. The GAAP definition of an event being probable is that “the event or events are likely to occur.” This leaves a significant amount of judgment up to the small business owner. As such, it is a good idea to confer with an outside party, such as your company attorney, to determine his take on the likelihood of a loss. There are certain cases or transactions when the final outcomes will not be known at that exact same time.

When is a Contingent Asset Not Recognized as an Asset?

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. IFRS Accounting Standards are, in effect, a global accounting language—companies in more than 140 jurisdictions are required to use them when reporting on their financial health. A company involved in a lawsuit that expects to receive compensation has a contingent asset because the outcome of the case is not yet known and the dollar amount is yet to be determined.

What Is A Contingent Asset

Qualifying contingent liabilities are recorded as an expense on the income statement and a liability on the balance sheet. A contingent asset is a potential economic benefit that is dependent on future events out of a company’s control. Not knowing for certain whether these gains will materialize, or being able to determine their precise economic value, means these assets cannot be recorded on thebalance sheet. However, they can be reported in the accompanying notes of financial statements, provided that certain conditions are met.

IFRIC 1 — Changes in Existing Decommissioning, Restoration and Similar Liabilities

Contingent asset accounting policies for GAAP, meanwhile, are mainly outlined in the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) Topic 450. Details on the level and composition of Japan’s international reserves/ foreign currency liquidity are provided below. Japan’s reserve assets totaled $ 1,294,637 million as of the end of December 2023, up $ 24,930 million from the end of November. Let’s explore a practical scenario involving a company embroiled in a legal dispute.

If the value can be estimated, the liability must have a greater than a 50% chance of being realized. Finally, the last category of items discussed in IAS 37 are contingent assets. A common example of a contingent asset could be a lawsuit where the entity could be entitled to receive the proceeds of a settlement. Contingent assets, tied to uncertain future events, demand prudent accounting. Premature recognition risks distorting financial statements and potentially misleading stakeholders. In this case, Rey Co would include a provision for the $10m legal provision in liabilities.

Although contingent liabilities are necessarily estimates, they only exist where it is probable that some amount of payment will be made. This is why they need to be reported via accounting procedures, and why they are regarded as “real” liabilities. A warranty is another common contingent liability because the number of products returned under a warranty is unknown.

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 different from contingent liabilities and contingent losses, which are recorded in accounts and reported on the financial statements when they are probable and the amount can be estimated. The information is still of importance to decision makers because future cash payments will be required. 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. Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity.

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