Financial statements follow certain accounting concepts and principles. But sometimes there may be a case where important and relevant information is left out of such statements due to these accounting concepts. One such case is that of contingent assets. Let us see its meaning and accounting treatment.
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A contingent asset is a potential asset or economic benefit for a company. It does not currently exist but may arise in the near future. The occurrence of such a contingent asset depends on the occurrence or the non-occurrence of a particular set of events over which the company itself does not have full control. Such an asset or economic interest arises from an uncertain and unpredictable event.
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. Or if the company is anticipating a merger. Another example would be if a company was expecting to be paid on account of a warranty.
Due to their uncertainty and in accordance with some accounting concepts, contingent assets do not find themselves on the balance sheet of a company. Let us enumerate the reasons a contingent asset is not recognized as an asset,
- Uncertain Event: The occurrence of such a benefit is not a given. Since the outcome of the event is not fully in control of the company we cannot guarantee its occurrence. There may be a case where we might recognize a contingent asset that never realizes. Hence they are kept off the balance sheet of the company.
- Conservatism: The conservatism principle clearly states that any uncertain future expense must be recognized immediately. But any future uncertain income must not be recognized. A contingent asset will come under the latter. The idea behind the principle was to record the lowest possible profit in the spirit of trueness and fairness of the financial statements.
Disclosure of Contingent Asset
There is an International Accounting Standard 37 (IAS 37) that outlines the treatment of contingent liabilities as well as contingent assets. And similarly, the ICAI has also published Accounting Standard 29 to deal with the same.
The AS 29 states that a contingent asset should not be disclosed in the financial statements following the accounting concept of prudence. However, the approving authorities can make a mention of the asset in their report. In the case of a company, this will be the report by the Board of Directors. But such a disclosure can be made in the report only if,
- The economic benefit is probable, i.e. more than likely to happen
- The amount of such an asset/benefit can be estimated reliably
Contingent assets are to be monitored very closely. Once it becomes certain that the economic benefit will arise, only then can they be included in the financial statements of the company. Then the asset is not a contingent asset anymore.
Solved Question for You
Q: A court orders that XYZ Co. must pay ABC Co. 25,000/- in damages. ABC Co. has not yet received the money. Can it recognize this contingent asset as an asset now?
Ans: Yes, now the contingent asset becomes an asset. Although the payment is not received, the court has ordered the payment. So the income has become virtually certain and can now be recognized as an asset.