What is a contingent asset?
Contingent assets are potential financial benefits that depend primarily on future events beyond the control of the company. Therefore, contingent assets are also known as potential assets.
Not knowing for sure whether these benefits will be realized, or being able to determine their exact economic value, means that these assets cannot be recorded. On the balance sheet. However, if certain conditions are met, they can be reported in the footnotes of the attached financial statements.
- Contingent assets are only valuable if certain events or conditions that are independent of the company’s own actions occur in the future.
- If certain conditions are met, contingent assets will be reported in the attached financial statement notes.
- Contingent assets can only be recorded on a company’s balance sheet when the realization of its associated cash flows is relatively certain.
Understand contingent assets
A contingent asset becomes a realizable asset that can be recorded on the balance sheet when the associated cash flows are relatively certain to be realized. In this case, the asset will be recognized during the period when the status change occurred.
Contingent assets can occur due to unknown economic value. Alternatively, it can be caused by uncertainty associated with the outcome of an event in which the asset may be created. You will see contingent assets due to previous events, but not all asset information will be collected until a future event occurs.
There are also contingent or potential debts. Unlike contingent assets, they refer to potential losses that can occur, depending on how a particular future event unfolds.
Example of contingent assets
The companies involved in the proceedings that are hoping to receive compensation have contingent assets because the outcome of the proceedings is still unknown and the amount has not yet been determined.
Let’s say ABC filed a proceeding against XYZ for infringing a patent. If ABC has a good chance of winning the proceedings, ABC has contingent assets. This potential asset is usually disclosed in the financial statements but is not recorded as an asset until the proceedings are resolved.
Based on this same example, XYZ must disclose potential contingent liabilities in a notebook and later record it in an account if it loses the proceedings and is ordered to pay damages.
Contingent assets also occur when a company expects to receive money through the use of guarantees. Other examples include benefits received from real estate or other court settlements. Expected mergers and acquisitions will be disclosed in the financial statements.
Both generally accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) provide contingent assets to a company when these potential benefits are well likely to be realized in the end. Disclosure is required. For US GAAP, there should normally be a 70% chance of making a profit. IFRS, on the other hand, is rather generous, and in general, companies can be aware of potential profits if they are at least 50% likely to generate potential profits.
International Accounting Standard 37 (IAS 37) applicable to IFRS states: “”Contingent assets are not recognized, but will be disclosed when there is a high likelihood of an inflow of benefits. However, if the inflow of benefits is virtually certain, the asset is no longer considered contingent and will be recognized in the statement of financial position. “
GAAP’s contingent asset accounting policy, on the other hand, is primarily outlined in the Financial Accounting Standards Board (FASB) Accounting Standards Coding (ASC) Topic 450.
Companies need to continually revalue their potential assets. When the likelihood of contingent assets increases, the entity must estimate the income it collects and report it in its financial statements. Estimates are generated using experience with a variety of possible outcomes, associated risks, and similar potential contingent assets.
Contingent assets are governed by the principles of conservatism. The principle of conservatism is accounting practice that states that uncertain events and outcomes should be reported in the way that the potential profits are lowest. In other words, companies are advised to discourage raising expectations and generally take advantage of the lowest estimated asset valuations.
In addition, profits from contingent assets cannot be recorded until they actually occur. The principle of conservatism supersedes the matching principle of accrual accounting. That is, the asset may not be reported until the period after the associated costs are incurred.