That standard replaced parts of IAS 10 Contingencies and Events Occurring after the Balance Sheet Date that was issued in 1978 and that dealt with contingencies. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, https://www.bookstime.com/ and innovator in teaching accounting online. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
IFRS Foundation publishes tenth compilation of IFRS Interpretations Committee agenda decisions
As part of the due diligence process, some potential investors look at a company’s prospectus, which must include all the information on its financial statements. Investors pay particular attention to items that reduce the company’s ability to generate profits, like contingent liabilities. Contingent liabilities can pose a threat to the reduction of net profitability and company assets. contingent liabilities meaning This means that they can potentially negatively impact the health and financial performance of a company. Ultimately, this is why these situations or circumstances must get disclosed in the financial statements of a company. The materiality principle outlines that any and all important financial information and matters must be disclosed in a company’s financial statements.
What Are Contingent Liabilities in Accounting?
Contingent liabilities aren’t recognised in the primary financial statements but should be disclosed in the notes. However, if the risk of a resource outflow is remote, then such liabilities shouldn’t be disclosed. Generally, a ‘remote’ likelihood ranges between 5% and 10%, though IAS 37 doesn’t explicitly specify this. IAS 37.86 details the disclosure requirements, emphasising that any contingent liability with an outflow possibility exceeding ‘remote’ should be disclosed. Under the generally accepted accounting principles (GAAP), contingent liabilities are recorded as actual liabilities only if the potential liability is probable and its amount can be reasonably estimated.
GAAP Compliance
Let us see the example where a person has purchased a motorcycle from a showroom and has a two-year warranty for the engine and the motorcycle. If the engine fails to work within six months of the purchase, the company has to replace the engine. Loss contingencies are accrued if determined to be probable and the liability can be estimated. But unlike IFRS, the bar to qualify as “probable” is set higher at a likelihood of 80%. Liabilities are called ‘contingent’ in the sense that they are by nature only potential and not actual liabilities.
FAQs About Contingent Liability
The company will record the liability in the books of accounts only if it is sure of its occurrence. This is done to ensure that it is within the rules of the generally accepted accounting principles (GAAP), or follows the International Financial Reporting Standards (IFRS). Based on an analysis of both these factors, the company can know what’s required for including the contingent liability in its financial statements. In some cases, the accounting standards require what’s called a note disclosure (a footnote) in the company’s reports.
First, the company must decide if the contingent liability should be recognized with an accounting transaction created and included in its reports. This process looks at the probability of the occurrence and whether the cost of the occurrence can be estimated. Any probable contingency needs to be reflected in the financial statements—no exceptions. Possible contingencies—those that are neither probable nor remote—should be disclosed in the footnotes of the financial statements. Essentially, the effect that contingent liabilities have on an audit depends on their likelihood of occurring in the first place.
- If the likelihood of resource inflow exceeds 50%, contingent assets are disclosed in the notes to financial statements (as per IAS 37.89) but aren’t recognised in the primary financial statements.
- Say an employer pays an employee “off the books” in cash and doesn’t report the income or the taxes, or pay the unemployment insurance for this employee.
- The ‘not-to-prejudice‘ exemption in IAS 37.92 is also applicable to contingent liabilities.
- Nonetheless, this agenda decision shouldn’t be generalised to regular legal proceedings where, facing an adverse verdict, an entity doesn’t retain any assets.
- If the lawsuit results in a loss, a debit is applied to the accrued account (deduction) and cash is credited (reduced) by $2 million.
- These types of contingencies usually include pending litigation and guarantees of indebtedness that exist when a company guarantees the collectability of a receivable that it has discounted at the bank.
