What Is a Contingent Asset?
Let me explain what a contingent asset is: it's a potential economic benefit that depends on some future event or events that are largely out of a company's control. You might also hear it called a potential asset.
Since you can't know for sure if these gains will actually happen, or what their exact economic value will be, these assets aren't recorded on the balance sheet. However, they can be mentioned in the footnotes of financial statements if certain conditions are met.
Key Takeaways
- 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 turns into a realized asset that you can record on the balance sheet when the cash flows tied to it become relatively certain. At that point, you recognize the asset in the period when the status changes.
These assets can arise because the economic value is unknown, or due to uncertainty about the outcome of an event that might create an asset. They stem from previous events, but you won't have all the details until future events unfold.
You should also know about contingent liabilities, which are the opposite—they represent potential losses that might occur depending on future events.
Examples of Contingent Assets
Consider a company involved in a lawsuit where it expects to receive compensation; that's a contingent asset because the outcome isn't known yet, and the amount is undetermined.
For instance, if Company ABC sues Company XYZ for patent infringement and there's a decent chance ABC will win, ABC has a contingent asset. You'll generally see this disclosed in the financial statements, but it won't be recorded as an asset until the lawsuit settles.
In the same scenario, Company XYZ would disclose a potential contingent liability in its notes and record it if they lose and have to pay damages.
Contingent assets also appear when companies expect money from warranties. Other cases include benefits from an estate, court settlements, or anticipated mergers and acquisitions, all of which need to be disclosed in financial statements.
Reporting Requirements
Both GAAP and IFRS require companies to disclose contingent assets if there's a decent possibility they'll be realized. Under U.S. GAAP, you generally need a 70% likelihood of the gain occurring. IFRS is a bit more flexible, allowing reference to potential gains with at least a 50% likelihood.
According to IAS 37 for IFRS, contingent assets aren't recognized but are disclosed when it's more likely than not that benefits will inflow. If the inflow is virtually certain, you recognize it as an asset on the balance sheet because it's no longer contingent.
For GAAP, the policies are outlined in FASB's ASC Topic 450.
Special Considerations
You have to continually reevaluate contingent assets. When one becomes likely, report it in the financial statements by estimating the income, using a range of outcomes, associated risks, and experience from similar cases.
These assets follow the conservatism principle, which means you report uncertain events in a way that shows the lowest potential profit. So, avoid inflating expectations and use the lowest estimated valuation.
Remember, you can't record any gain from a contingent asset until it actually happens. This principle overrides the matching principle in accrual accounting, so the asset might not be reported until after related costs were incurred.
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