IAS 37 governs the treatment of contingent assets and contingent liabilities. However, this standard does not cover assets and liabilities that fall under the scope of another standard, as highlighted in IAS 37.2-5. Importantly, all contractual rights or obligations must be accounted for under the relevant standards, often IFRS 15 or IFRS 9. A common misconception is referring to IAS 37 whenever a contractual right or obligation is contested by any party.
Definition of contingent liability
According to IAS 37.10 and IAS 37.27-30, a contingent liability is:
- A possible obligation resulting from past events, the existence of which will be confirmed only by the occurrence or non-occurrence of uncertain future events outside the entity’s control; or
- A present obligation that remains unrecognised because:
– It’s not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
– The obligation cannot be measured with sufficient reliability (which is rare).
Disclosure of contingent liabilities
Contingent liabilities aren’t recognised in the primary financial statements but should be disclosed in the notes. However, if the risk of a resource outflow is remote, then such liabilities shouldn’t be disclosed. Generally, a ‘remote’ likelihood ranges between 5% and 10%, though IAS 37 doesn’t explicitly specify this. IAS 37.86 details the disclosure requirements, emphasising that any contingent liability with an outflow possibility exceeding ‘remote’ should be disclosed. However, individually immaterial items can be grouped into classes.
The ‘not-to-prejudice‘ exemption in IAS 37.92 is also applicable to contingent liabilities.
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Definition of contingent asset
A contingent asset is a potential asset resulting from past events, and its existence will be confirmed only by uncertain future events not entirely under the entity’s control (IAS 37.10; IAS 37.31-35).
Recognition and disclosure of contingent assets
If the likelihood of resource inflow exceeds 50%, contingent assets are disclosed in the notes to financial statements (as per IAS 37.89) but aren’t recognised in the primary financial statements. If it becomes ‘virtually certain’ (roughly 90-95%, not explicitly defined in IAS 37) that resources will flow in, then the asset is recognised in the statement of financial position and profit or loss. For likelihoods under 50%, no disclosure is made.
The ‘not-to-prejudice‘ exemption in IAS 37.92 also extends to contingent assets. Additionally, see the forum’s discussion regarding a scenario where a once-recognised contingent asset’s likelihood of resource inflow is no longer virtually certain.
Continuous reassessment
Contingent liabilities are subject to continuous reassessment due to the possibility of their development differing from initial expectations. This ongoing evaluation is crucial to ascertain whether a probable outflow of resources has become probable. When an outflow of future economic benefits for an item, previously classified as a contingent liability, becomes probable, it necessitates the recognition of a provision in the period during which this change in probability is identified (IAS 37.30).
Similarly, the evaluation of contingent assets is a continuous process, ensuring that any developments are accurately represented in the financial statements. If it becomes virtually certain that there will be an inflow of economic benefits, the corresponding asset and related income are to be recognised in the period in which this certainty arises. Moreover, if the likelihood of an economic benefit inflow increases to the level of probability, the entity is required to disclose the contingent asset (IAS 37.35).
Deposits paid in ongoing proceedings
A noteworthy agenda decision revolves around the accounting treatment of a deposit made to tax authorities. In the scenario discussed by the IFRS Interpretations Committee, an entity, confident about winning a dispute with tax authorities, pays the disputed amount as a deposit to avert penalties if it loses. Upon resolution, the deposit will either be refunded to the entity (if it wins) or offset against the obligation (if it loses). The Committee concluded that this deposit constitutes an asset, and the entity isn’t required to be virtually certain of a favourable outcome to recognise it (as opposed to expensing this amount). The deposit ensures future economic benefits, either through a cash refund or settling the liability. Nonetheless, this agenda decision shouldn’t be generalised to regular legal proceedings where, facing an adverse verdict, an entity doesn’t retain any assets. In such instances, the ‘virtually certain’ threshold is applicable before a disputed asset can be recognised.