What Is a Contingent Asset?
A contingent asset is a potential economic benefit that is dependent on some future event(s) largely out of a company’s control. A contingent asset is thus also known as a potential asset.
Not knowing for certain whether these gains will materialize, or being able to determine their precise economic value, means these assets cannot be recorded on the balance sheet. However, they can be reported in the accompanying footnotes of financial statements, provided that certain conditions are met.
- A contingent asset is only valuable if certain events or conditions that are independent of a company's own actions come to pass in the future.
- Upon meeting certain conditions, contingent assets are reported in the accompanying notes of financial statements.
- A contingent asset can be recorded on a firm's balance sheet only when the realization of cash flows associated with it becomes relatively certain.
Understanding Contingent Assets
A contingent asset becomes a realized asset recordable on the balance sheet when the realization of cash flows associated with it becomes relatively certain. In this case, the asset is recognized in the period when the change in status occurs.
Contingent assets may arise due to the economic value being unknown. Alternatively, they might occur due to uncertainty relating to the outcome of an event in which an asset may be created. A contingent asset appears because of previous events, but the entirety of all asset information will not be collected until future events happen.
There also exists contingent or potential liabilities. Unlike contingent assets, they refer to a potential loss that may be incurred, depending on how a certain future event unfolds.
Examples of Contingent Assets
A company involved in a lawsuit that expects to receive compensation has a contingent asset because the outcome of the case is not yet known and the dollar amount is yet to be determined.
Let’s say Company ABC has filed a lawsuit against Company XYZ for infringing a patent. If there is a decent chance that Company ABC will win the case, it has a contingent asset. This potential asset will generally be disclosed in its financial statement, but not recorded as an asset until the lawsuit is settled.
Based on this same example, Company XYZ would need to disclose a potential contingent liability in its notes and then later record it in its accounts, should it lose the lawsuit and be ordered to pay damages.
Contingent assets also crop up when companies expect to receive money through the use of a warranty. Other examples include benefits to be received from an estate or other court settlement. Anticipated mergers and acquisitions are to be disclosed in the financial statements.
Both generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) require companies to disclose contingent assets if there is a decent possibility that these potential gains will eventually be realized. For U.S. GAAP, there generally needs to be a 70% likelihood that the gain occurs. IFRS, on the other hand, is slightly more lenient and generally permits companies to make reference to potential gains if there is at least a 50% likelihood that they will occur.
International Accounting Standard 37 (IAS 37), applicable to IFRS, states the following: “Contingent assets are not recognized, but they are disclosed when it is more likely than not that an inflow of benefits will occur. However, when the inflow of benefits is virtually certain an asset is recognized in the statement of financial position because that asset is no longer considered to be contingent.”
Contingent asset accounting policies for GAAP, meanwhile, are mainly outlined in the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) Topic 450.
Companies must reevaluate the potential asset continually. When a contingent asset becomes likely, firms must report it in financial statements by estimating the income to be collected. The estimate is generated using a range of possible outcomes, the associated risks, and experience with similar potential contingent assets.
Contingent assets are ruled under the conservatism principle, which is an accounting practice that states that uncertain events and outcomes should be reported in a manner that results in the lowest potential profit. In other words, companies are discouraged from inflating expectations and are generally advised to utilize the lowest estimated asset valuation.
In addition, no gain may be recorded from a contingent asset until it actually occurs. The conservatism principle supersedes the matching principle of accrual accounting, meaning the asset may not be reported until a period after associated costs were incurred.