Contingent Assets and Liabilities

1 Contingent liability

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Link the evidence to the recognition decision: identify the present or possible obligation, assess the probability of an outflow and whether it can be measured reliably, then conclude on provision, disclosure or neither. Do not stop at the label ‘contingent liability’.

A contingent liability is a possible liability arising from past events but the existence of that liability will only be confirmed by future events.

Note it’s very important that the possible liability arises from past events. We are not trying to foresee events which may arise in the future and which give rise to liabilities.

The treatment of the liability depends on how probable it is that there will be an outflow of resources from the company:

If the present obligation probably requires the outflow of resources, a provision will be required for the best estimate of the liability. In other words an expense account could be debited and some sort of accrual or liability account will be credited.
If it is a possible obligation that will probably not require the outflow of resources, no provision is required but disclosure should be made by way of a note to the financial statements.
If the outflow of resources is remote, in other words very unlikely, no provision and no disclosure is required.

A good example of contingent liability is a legal action arising from some past event: if it is probable that you are going to have to pay up, set up a provision; if it’s merely possible you have to pay up, no provision is needed but the risk should be disclosed. If it is very unlikely that you are going to have to pay up, no provision and no disclosure.

It can be difficult to assess probability of a liability actually crystallizing and auditors will have to review correspondence with, for example, solicitors and also look at board minutes.

2 Contingent asset

A contingent asset is a possible asset arising from past events but whose existence will only be confirmed by future events.

The treatment of contingent asset is similar to that of contingent liabilities, but more cautious.

If an inflow of economic benefits is virtually certain then the asset is not contingent: it’s a real asset and should be shown in the statement of financial position.
If the inflow of economic benefits is merely probable, not virtually certain, then it would be imprudent to recognise an asset. However, as an asset is more likely than not to materialise, it should be disclosed in a note to the financial statements.
If the inflow is not probable, it is not expected to materialise and does not merit disclosure.

Note that the treatment of contingent assets and liabilities though similar is not symmetrical:

Flow of resources	Outflow	Inflow
Remote	No disclosure	No disclosure
Probably not, but possible	Contingent liability disclosure	No disclosure
Probable	Provision (if reliable estimate) – otherwise a contingent liability	Disclosure required
Expected/virtually certain	Provision	Asset (i.e. not contingent)

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