Contingent Assets and Liabilities IAS 37

(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. Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. A provision shall be used only for expenditures for which the provision was originally recognised. Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph 85(b). The provision is measured before tax, as the tax consequences of the provision, and changes in it, are dealt with under IAS 12. Note — This is based on the assumption that the entire cost overrun was on account of delay in handing over of land to Developer by the Authority.

Consequently, the provision will increase each year until it becomes $20m at the end of the asset’s 25-year useful life. EXAMPLE Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. 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. 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. 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.

Contingent Assets vs. Contingent Liabilities

A contingent liability is not recognised 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. A provision is 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 at that time.

1. Other candidates may calculate an expected value based on the various probabilities which also would not be appropriate in these circumstances.
2. Doing so at least reveals the presence of a possible asset to the readers of the financial statements.
3. Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation.

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. 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 personal and business banking twin cities achieve the results that their various stakeholders wanted. IFRS 15 Revenue from Contracts with Customers, issued in May 2014, amended paragraph 5 and deleted paragraph 6. Future operating losses do not meet the definition of a liability in paragraph 10 and the general recognition criteria set out for provisions in paragraph 14.

Paragraphs 72⁠–⁠83 set out how the general recognition criteria apply to restructurings. In most cases the entity will remain liable for the whole of the amount in question so that the entity would have to settle the full amount if the third party failed to pay for any reason. In this situation, a provision is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is recognised when it is virtually certain that reimbursement will be received if the entity settles the liability. It is not necessary, however, to know the identity of the party to whom the obligation is owed—indeed the obligation may be to the public at large. 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 the balance sheet.

Onerous contracts

This is effectively an attempt to move $3m profit from the current year into the next financial year. Definition of Material (Amendments to IAS 1 and IAS 8), issued in October 2018, amended paragraph 75. An entity shall apply those amendments prospectively for annual periods beginning on or after 1 January 2020. An entity shall apply those amendments when it applies the amendments to the definition of material in paragraph 7 of IAS 1 and paragraphs 5 and 6 of IAS 8. Thus, it may be appropriate to treat as a single class of provision amounts relating to warranties of different products, but it would not be appropriate to treat as a single class amounts relating to normal warranties and amounts that are subject to legal proceedings.

[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. In such cases, an entity need not disclose the information, but shall disclose the general nature of the dispute, together with the fact that, and reason why, the information has not been disclosed. A contingent asset nonqualified deferred compensation plan faqs for employers is disclosed, as required by paragraph 89, where an inflow of economic benefits is probable. A contingent liability is simply a disclosure note shown in the notes to the accounts.

However, Contingent Asset does not form part of the Company’s Annual Report unless it becomes certain. Unlike contingent assets, they refer to a potential loss that may be incurred, depending on how a certain future event unfolds. Alternatively, they might occur due to uncertainty relating to the outcome of an event in which an asset may be created.

For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. EXAMPLE – expected value Rey Co gives a year’s warranty with all goods sold during the year. Rey Co’s manufacturing manager has calculated that if minor repairs were needed on all goods, it would cost $100,000 and major repairs on all goods would cost $1m. It is not uncommon for candidates to incorrectly take the $12m, thinking that the worst-case scenario should be provided for.

Relationship between provisions and contingent liabilities

Evidence is required both of what legislation will demand and of whether it is virtually certain to be enacted and implemented in due course. In many cases sufficient objective evidence will not exist until the new legislation is enacted. The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision. In the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation. An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

A contingent asset is a potential economic benefit that is dependent on some future event(s) largely out of a company’s control. 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 time value of money If the time value of money is material (generally if the potential outflow is payable in one year or more), the provision should be discounted to present value initially.

Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognised in the financial statements of the period in which the change occurs. If an inflow of economic benefits has become probable, an entity discloses the contingent asset (see paragraph 89). In a general sense, all provisions are contingent because they are uncertain in timing or amount. In addition, the term ‘contingent liability’ is used for liabilities that do not meet the recognition criteria. Similar to the concept of a contingent liability is the concept of a contingent asset.

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. Again, a description of the event should be recorded in addition to any potential amount. The key difference is that a contingent asset is only disclosed if there is a probable future inflow, rather than a possible one. The table below shows the treatment for an entity depending on the likelihood of an item happening. A contingent asset is a possible asset that may arise because of a gain that is contingent on future events that are not under an entity’s control.

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. EXAMPLE – Likelihood Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery. 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. 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.

For U.S. GAAP, there generally needs to be a 70% likelihood that the gain occurs. IFRS, on the other hand, is slightly more lenient and generally permits companies to make reference to potential gains if there is at least a 50% likelihood that they will occur. IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets. This Standard defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.