In accounting a contingent asset is a possible asset the business will receive at some point but the existence of these benefits, and control over them, is to be confirmed by future events. Contingent assets are not to be recognised in the financial statements but rather form part of the notes to those statements.
The accounting treatment of contingent assets is largely set out in IAS 37 Provisions, Contingent Liabilities and Contingent Assets, which we will be referring to in this tutorial. You may wish to also see our tutorials on Provisions and Contingent Liabilities.
Contingent Asset Analysis
In the International Financial Reporting Standards (IFRS) Conceptual Framework it is very clear what the definitions of the five elements of the financial statements are; being revenue, expenses, liabilities, capital and of course assets. And under the framework (section 4.3) an asset is defined as:
… a present economic resource controlled by the entity as a result of past events.
So lets break these elements of an asset down and see why a contingent one is then not recognised in the financial statements.
Present Economic Resource
So an economic resource might be a physical asset, a third party’s debt or the right to receive money in the future. A contingent asset would meet this criteria because we have identified some form of economic benefits to be received.
The breakdown from an asset being recognised in the financial statements to rather being disclosed as a note to the statements can arise due to the certainty around whether:
a. the event will arise; or
b. how to measure the value of the economic resource of benefit.
IAS 37 requires us to have virtual certainty around the recognition of these assets, not that they are just possible or even probable.
Controlled by the Entity
This is a really important point about assets that is often missed. We traditionally think of assets as being things we need to own, in a legal sense. However, accounting in more recent times, in particular with the development of conceptual frameworks, the view is an entity being able to control economic benefits rather than actual legal ownership of them. And this control of course extends to the ability to control third party access to those benefits.
An example of control rather than ownership would be say under a lease deal. The entity may not own the machinery but now under IFRS 16 Leases, the leasee must bring to account the machinery as an asset and the lease obligation as a liability. In the “good old days” there was this constant battle between operating v finance lease agreements.
The breakdown here from asset to contingent asset is what is being controlled. If there is uncertainty in when event(s) will arise and/or the measurability of those economic benefits, the question of control cannot be answers.
As a Result of Past Events
As at the date of reporting an asset can only be recognised if has arise of things that have already taken place, for example a contract has been signed or certain contractual milestones have been achieved or goods have been delivered.
And this is where we will normally see an asset move of an asset from being recognised in the financial statements to being disclosed as a note to those statements. The events that will bring into clarity what economic benefits are being discussed, how they are to be measured and then who controls them are waiting for certain future events to taken place.
Why Not Allow Contingent Asset Recognition?
IAS 37 does not allow contingent assets to be recognised, ie to be treated as an asset in the statement of financial position, because this could result in the accounts being misstated. And how could that arise? Because the events around this asset are uncertain the is a reasonable chance it never arises at all or the amount is materially different.
However of course once the control over those economic benefits is “virtually certain” (IAS 37. para 33) they are to be brought to account.
IAS 37 contains a lot more material covering such areas as provisions, reimbursements and restructurings. If you would like to know more about these please use the search feature on our site or hopefully I’ve come back to provide the proper links here.
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