Contingent assets under IAS 37

This article answers the following questions:

• When do contingent assets arise?
• Why should contingent assets be continuously monitored?
• What does IAS 37 say about contingent assets?

In our accounting and auditing blog, in the article "IAS 37 and liabilities and provisions for liabilities", we have already touched on the issue of liabilities and provisions for liabilities, also discussing contingent liabilities. However, accounting professionals rarely address the related topic of contingent assets. While the information related to them doesn't appear directly on an entity's balance sheet, this doesn't mean they are irrelevant and shouldn't be closely monitored. So, what is the definition of a contingent asset and how should they be disclosed in the accounts?

What is a contingent asset?

The Polish Accounting Act fails to offer a definition of a contingent asset. However, International Accounting Standard 37 (IAS 37) is helpful in this regard.

As defined in IAS 37, 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."

Let's break down this definition and examine its components to see what exactly they mean. A contingent asset is:

• a possible asset – a contingent asset is not yet a regular asset – it may become one someday, but that may as well never happen; it is worth noting the term “possible” here, as it also refers to the degree of probability,
• an asset that arises from past events – the event causing its creation must have already occurred,
• an asset whose existence will only be confirmed in the future – whether the contingent asset will ultimately exist will only become clear in the future, so at the moment of its assessment we are still dealing with a possibility, not a certainty,
• an asset whose existence depends on the occurrence or non-occurrence of uncertain future events that are beyond the entity's control – therefore, there is uncertainty about the events (or lack thereof) that condition the future existence of this asset, and whose occurrence is also wholly or partly beyond the entity's control.

How are contingent assets created?

Contingent assets most often arise from unexpected events that imply a probable inflow of economic benefits to the entity. However, this inflow is uncertain. So, how do these assets function in practice, and when can they be considered to exist? Let's analyse two case scenarios to which the provisions discussed here can be applied.

Example 1

A business owner believes they have suffered damage but the perpetrator denies any wrongdoing. Therefore, the business owner has filed a lawsuit seeking compensation. Compensation is a contingent asset, as whether it will be awarded remains uncertain until a favourable judgment is announced, resulting in the inflow of economic benefits. Furthermore, the damage occurred in the past, but the judgment will be issued in the future and is difficult to predict, as it is up to the court's discretion.

Example 2

A company applied for a European Union subsidy but obtaining it required assurance that it would meet specific conditions within the next five years. However, meeting these requirements in their entirety is beyond the company’s direct control. Certainty that the subsidy will be received and not repaid will be achieved in the future – in subsequent years – as only then will it be clear whether the company has met all the conditions. In this case, the inflow of economic benefits to the company is probable but not certain, so the subsidy constitutes a contingent asset.

Disclosure of contingent assets in the financial statements

When preparing to draft and audit financial statements, it is important to remember that contingent assets are not recognised in the balance sheet or profit and loss account as this could result in the recognition of revenue that has not (and will not) be earned. If the future generation of this revenue were certain or virtually certain, the asset would not be contingent but would constitute a regular asset and would be recognised in the financial statements.

However, contingent assets are to be disclosed in the notes to the financial statements (if the resulting economic benefits are probable), together with the description of their nature and, if possible, the estimation of their financial impact. However, this estimation can indeed pose a challenge as, firstly, IAS 37 does not explicitly state any principles for measuring contingent assets and, secondly, including information that could potentially be misleading in assessing the probability of generating revenue from them should be avoided.

How to simplify the process of disclosing assets in the accounting records in this case? The table below will certainly prove helpful.

The method of classifying a contingent asset depending on the degree of probability of a future event occurring

Source: own elaboration based on: A Guide through IFRS Standards, part A, IFRS Foundation, London 2016, p. 1335 – IFRS 37.

Before initiating the audit of the financial statements, it is worth consulting the disclosure of assets with an expert

Contingent assets need to be monitored on an ongoing basis – not just when preparing the accounts for year-end – as over time, future events become a thing of the past and, in the meantime, the inflow of economic benefits may become certain. This will naturally call for the recognition of revenue in the financial statements – in the period in which this certainty is gained.

A proper understanding of contingent assets (and their accurate disclosure in the notes to the financial statements) can therefore significantly affect the quality and transparency of the financial information published by an entity. If you require assistance with the correct disclosure of contingent assets and financial reporting, we encourage you to reach out to RSM Poland auditors, who, as accounting experts, help accountants and business owners develop relevant procedures aimed at ensuring the clarity of processes and accounting records.