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 confirmed by future events. Contingent assets are not to be recognised in the financial statements but instead form part of the notes to those statements.
The accounting treatment of contingent assets is primarily set out in IAS 37 Provisions, Contingent Liabilities and Contingent Assets, which we will be referring to in this tutorial. You may also wish to see our tutorials on Provisions and Contingent Liabilities.
Contingent Asset Analysis
In the International Financial Reporting Standards (IFRS) Conceptual Framework, 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 let’s break down an asset’s key elements and see why a contingent asset is not in the financial statements.
Present Economic Resource
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 these criteria because we have identified some form of economic benefits to be received.
The difference in an asset being in the financial statements to being disclosed as a note arises from certainty of:
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 recognising these assets, not that they are just possible or even probable.
Controlled by the Entity
We traditionally think of assets as being things we need to own in a legal sense. However, in more recent times, in particular, with the development of conceptual frameworks, the view is an entity controlling economic benefits rather than their legal ownership. And this control, of course, extends to the ability to manage 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 lessee must recognise 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. Whereas under the consignment of inventory, both control and ownership of the assets remains with the consignor.
The breakdown here from asset to a contingent asset is around control. And the question of control cannot be addressed if there is uncertainty in when an event(s) will arise or the measurability of those economic benefits.
As a Result of Past Events
At the reporting date, an asset is recognised if it has arisen from events 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 clarify what economic benefits are being discussed, how they are to be measured, and who control them are waiting for certain future events.
Why Not Allow Contingent Asset Recognition?
IAS 37 does not allow contingent assets to be recognised, i.e. treated as an asset on the balance sheet. The reason for IAS 37’s ban is a contingent asset could misstate the accounts. And how could that arise? Because the events around this asset are uncertain, they may never occur, or the amount is materially different.
However, we must recognise the asset once the control over those economic benefits is “virtually certain” (IAS 37. para 33).
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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