Contingent Liability & Contingent Asset – Ind AS 37
What is a contingent liability?
- A contingent liability is
- a possible obligation 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; or
- a present obligation that arises from past events but is not recognized because
- it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
- the amount of the obligation cannot be measured with sufficient reliability
How to deal in books / Financial Statement?
- A contingent liability is not recognized in the books but disclosed in notes to financials unless the possibility of an outflow of resources embodying economic benefits is remote
Regular review / assessment and subsequent change in treatment:
- Contingent liabilities may develop in a way not initially expected
- Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable
- If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognized in the financial statements of the period in which the change in probability occurs
You might face a lawsuit, but your lawyers estimate the probability of losing the case at 30% – in this case, it’s not probable that you will have to incur any expenditures to settle the claim and you should not book a provision. It’s typical contingent liability
If you identify you have a contingent liability, you do NOT recognize it – no journal entry. You should only make appropriate disclosures in the notes to the financial statements
Facts: After a wedding in 2018, ten people died, possibly as a result of food poisoning from products sold by the entity. Legal proceedings are started seeking damages from the entity. The entity disputes any liability and, up to the date on which its financial statements for the year ended 31 December 2018 are authorized for issue, its lawyers have advised that is probable that the entity will not be found liable. However, when the entity prepares its financial statements for the year ended 31 December 2019, its lawyers advise that, owing to developments in the case, it is probable that the entity will be found liable.
At 31 December 2018, no provision is recognised and the matter is disclosed as a contingent liability unless the probability of any outflow is regarded as remote. On the basis of the evidence available when the financial statements were approved, there is no obligation as a result of a past event.
At 31 December 2019, a provision is recognized for the best estimate of the amount required to settle the obligation. The fact that an outflow of economic benefits is now believed to be probable means that there is a present obligation
Contingent Asset – Ind AS 37
What is 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
- Generally, a contingent asset is neither recognized in the books of accounts nor disclosed in noted to financials unless
- realization of Income is virtually certain or
- an inflow of economic benefits is probable
- In case realization of Income is virtually certain: The related asset is not a contingent asset and its actual recognition is appropriate
- In case an inflow of economic benefits is probable: A contingent asset is disclosed.
- Below is the summary of when the Provisions, Contingent liability and contingent assets should be recognized / disclosed in Financials / Notes to financials based on Likelihood of Inflow / outflow of economic resources
Facts: An entity has filed a legal case on its supplier for liquidated damages of Rs. 3 million. The supplier has disagreed with the claim and is unwilling to make settlements outside court. In this case an inflow of economic benefits is not probable.
Subsequently, the court ruled a judgment in favor of the entity. However, the supplier has filed an appeal against the court order. Management of the entity is of the opinion that again the court order will be in its favor. In this case, it will be appropriate to disclose this amount as contingent asset as the inflow of economic benefits is probable.
Recognition of asset in the books will be appropriate when the final decision in the favor of entity is received and there is virtual certainty of inflow of economic benefits.