Contingent assets and contingent liabilities are dealt with in IAS 37, except for assets and liabilities covered by another standard, as listed in paragraph IAS 37.5. See also the discussion on contractual assets and liabilities.
What is a contingent liability?
A contingent liability is (IAS 37.10; 27-30):
- 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 recognised 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 (extremely rare cases).
Contingent liability is a disclosure in the notes to financial statements only. Unlike provisions, contingent liabilities are not recognised in the statement of financial position or in P/L.
Disclosure of contingent liabilities
Contingent liabilities should be disclosed unless the possibility of outflow of resources is remote (say 5%-10%, exact probability threshold is not specified in IAS 37). Disclosure requirements are specified in paragraph IAS 37.86. Note that IAS 37 requires a disclosure of all contingent liabilities for which the possibility of outflow of resources is higher than remote. Individually immaterial items can be grouped into classes.
The ‘not-to-prejudice‘ exception in IAS 37.92 applies to contingent liabilities as well.
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 (IAS 37.10; 31-35).
Similarly to a contingent liability, a contingent asset is ‘only’ a disclosure in the notes to financial statements only, i.e. it is not recognised in the statement of financial position or P/L.
Recognition and disclosure of contingent assets
If the probability of inflow of resources is greater than 50%, contingent asset is disclosed (IAS 37.89) in the notes to financial statements (but not recognised in the statement of financial position). When it is virtually certain (say 90-95%, exact probability not specified in IAS 37) that the inflow of resources will take place, an asset is recognised in the statement of financial position.
If the probability of inflow of resources is lower than 50%, entities do not provide any disclosure.
Contractual assets and liabilities
It is important to note that if a ‘contingent’ asset or liability result from contractual terms, they are within the scope of IFRS 15 or IFRS 9 and should be recognised under the criteria specified in these standards. This specifically means that the ‘virtually certain’ criterion does not apply to contractual assets. It is a common mistake not to recognise disputed contractual asset due to the failure to meet the virtually certain threshold set out in IAS 37.
Deposits paid in ongoing proceedings
An interesting IFRIC agenda decision covers accounting treatment of a deposit paid to tax authorities. In the scenario discussed, an entity is in a dispute with tax authorities and believes that it will win before the court. However, in order to avoid penalties in case the dispute is lost, it pays the disputed amount to tax authorities as a deposit. After the case is resolved, the paid amount will be paid back to the entity (if the case is won) or used to settle the obligation (if the case is lost). IFRIC concluded that the paid amount gives rise to an asset and the entity does not need to be virtually certain that it will win the dispute in order to recognise that asset (instead of an expense in P/L). This is because the deposit gives the entity a right to obtain future economic benefits, either by receiving a cash refund or by using the payment to settle the liability.