A contingent asset is a potential asset that may become an actual asset depending on future events. In other words, it's an asset that is not currently recognized because it's not confident that the asset will be realized.
A contingent asset is
- A possible asset that arises from past events, and
- Whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the enterprise?
Accounting for Contingent Assets
Contingent assets should not be recognized but should be disclosed in those cases where an inflow of economic benefits is probable. When the realization of income is virtually certain, the related asset is not a contingent asset, and its recognition is appropriate.
Contingent assets are not recorded in the financial statements because there is uncertainty surrounding their existence. For example, if a company is involved in a lawsuit and it is uncertain whether it will win the case, any potential proceeds from the lawsuit would be considered a contingent asset.
If the uncertainty surrounding the existence of a contingent asset disappears, then the asset is no longer considered to be contingent and should be recognized in the financial statements. For example, if the company mentioned above wins its lawsuit, its proceeds would no longer be considered a contingent asset. They would be recorded as revenue on the company's income statement.
Types of Contingent Assets
There are two types of contingent assets: (1) legal claims and (2) uncollectible receivables.
A legal claim is a right or advantage one party has over another due to past events. Legal claims can take many forms, such as breach of contract, personal injury, defamation, etc.
An uncollectible receivable is an amount a company expects to receive but may not collect because the customer cannot pay. Uncollectible receivables are commonly written off as bad debt expenses when they become due and payable but remain unpaid. However, there is always a chance that an uncollectible receivable may be collected at some point in the future, which is why they are classified as contingent assets.
Example of Contingent Assets
- During the current year, a trial court found that a leading multinational company had infringed on certain patents and trademarks owned by the company. The court awarded $200 million in damages for these alleged violations by the defendant. By the court order, the defendant will also be required to pay interest on the award amount and legal costs. Should the defendant appeal to an appellate court, the trial court's verdict be reduced, or could the damages be reduced? Therefore, at the end of the reporting period, the company has not recognized the award amount in the accompanying financial statements since it is not virtually certain of the appellate court's verdict.
- In June 20XX, the company settled its longtime copyright infringement and trade secrets lawsuit with a competitor. Under the settlement terms, the competitor paid the company $5 million, which was received in the full and final settlement in October 20XX, and the parties have dismissed all remaining litigation. For the year ended December 31, 20XX, the company recognized the amount received in the settlement as "other income," which is included in the accompanying financial statements.
Disclosure of contingent assets
IAS 37 requires disclosure of contingent assets where an inflow of economic benefits is probable. The disclosures required are:
- a brief description of the nature of the contingent assets at the end of the reporting period; and
- Where practicable, an estimate of their financial effect is measured using the principles set out for provisions in paragraphs 36-52 of IAS 37.
In the case of contingent assets where an inflow of economic benefits is probable, an entity should disclose a brief description of the nature of the contingent assets at the end of the reporting period and, where practicable, an estimate of their financial effect, measured using the same principles as provisions.
That fact should be disclosed where any of the above information is not disclosed because it is not practical to do so. In extremely rare circumstances, if the above disclosures, as envisaged by the standard, are expected to seriously prejudice the position of the entity in a dispute with third parties on the subject matter of the contingencies, then the standard takes a lenient view and allows the entity to disclose the general nature of the dispute, together with the fact that, and the reason why the information has not been disclosed.
One problem that arises with IAS 37 is that it requires the disclosure of an estimate of the potential financial effect for contingent assets to be measured in accordance with the measurement principles in the standard. Unfortunately, the measurement principles in the standard are all set out in terms of the settlement of obligations, and these principles cannot readily be applied to the measurement of contingent assets. Hence, judgement will have to be used as to how rigorously these principles should be applied.
Contingent assets are potential assets that may become actual assets depending on future events. They are not currently recognized because it's not certain that the asset will be realized. If the uncertainty surrounding the existence of a contingent asset disappears, then the asset is no longer considered to be contingent and should be recognized in the financial statements. There are two types of contingent assets: (1) legal claims and (2) uncollectible receivables.