A contingent asset is a possible inflow of economic benefits to an entity that it should not recognize in the financial statements but should be disclosed in the notes.
In this article, we will focus on the latter concept.
A contingent asset arises from an event that may have a certain probability of occurrence.
For example, an entity may file a lawsuit against another company for breach of a contract.
There are three possibilities for the outcome of this economic event.
The first possibility is that the plaintiff entity has absolute certainty of a favorable demand resolution.
The second possibility is a certain probability of a positive result of the demand.
And finally, there is a remote possibility of the entry of economic benefits to the entity resulting from the demand.
All these possible outcomes are explained below.
The entry of economic benefits is practically certain
As soon as the management of an entity determines that the inflow of resources from some event that in some moment was considered probable now it’s considered certain, the economic event is no longer contingent.
For example, in year 1, a company files a lawsuit against a state entity for copyright infringement.
At the end of the reporting period, the entity’s lawyers consider that it is practically certain that the claim result will be resolved in favor of the entity.
In this case, the entity should recognize an account receivable since there is no uncertainty associated with the outcome of this event and the inflow of economic benefits is certain.
In this way, the transaction would no longer be within IAS 37, and now, it would be a financial instrument that the entity must recognize under IFRS 9.
The inflow of economic benefits is probable
On the other hand, when it’s considered that there may be a probability of entry of economic resources associated with an uncertain event, and it’s set out that a favorable resolution of this situation is possible, the entity must disclose this situation in the notes to financial statements.
It is essential to say that an entity should never recognize a contingent asset in the balance sheet.
Still, it should be reported that there may be some possibility that specific resources will enter the entity.
However, as we said before when there is the absolute security of the entry of these resources, the entity must recognize a real asset that should not be disclosed but should be included in the balance sheet.
For example, an entity estimates that there is some possibility of receiving $100,000 to resolve an environmental lawsuit.
The company’s lawyers consider a 70% probability of winning the trial that will take place within a year.
In this example, the entity should disclose in the notes to the financial statements that there is a high percentage probability that specific resources will flow into the entity.
When the judge rules in favor of the entity, the company must recognize an account receivable against the defendant entity must be recognized for the amount established in the claim.
The inflow of economic benefits is not probable
When management considers that it is practically impossible to get a favorable result in the resolution of a dispute, the entity should not do anything.
In other words, IAS 37 does not require disclosure of some events that the company considers will not occur.
For example, a company files a lawsuit against a media outlet for damages to the good name.
Historically, no company has won a lawsuit of this nature, and the entity’s lawyers consider that it is unlikely for the company to get favorable results in the trial.