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1.70, , PRINCIPLES AND PRACTICE OF ACCOUNTING, , UNIT – 5 CONTINGENT ASSETS AND CONTINGENT LIABILITES, LEARNING OUTCOMES, After studying this unit, you will be able to:, ♦, , Understand the meaning of the terms ‘Contingent Assets’ and ‘Contingent Liabilities’., , ♦, , Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’, , UNIT OVERVIEW, Contingent Asset, , Contingent Liability, 5.1, , • A possible asset arises from past events and their, existence will be confirmed only after occurrence or nonoccurrence of one or more uncertain future events., , • A possible obligation arising from past events and may arise, in future depending on the occurrence or non-occurrence of, one or more uncertain future events., , CONTINGENT ASSET, , A contingent asset may be defined as a possible asset that arises from past events and whose existence will be, confirmed only after occurrence or non-occurrence of one or more uncertain future events not wholly within the, control of the enterprise. It usually arises from unplanned or unexpected events that give rise to the possibility, of an inflow of economic benefits to the business entity. For example, a claim that an enterprise is pursuing, through legal process, where the outcome is uncertain, is a contingent asset., As per the concept of prudence as well as the present accounting standards, an enterprise should not recognise, a contingent asset. These assets are uncertain and may arise from a claim which an enterprise pursues through, a legal proceeding. There is uncertainty in realisation of claim. It is possible that recognition of contingent assets, may result in recognition of income that may never be realised. However, when the realisation of income is virtually, certain, then the related asset no longer remains as contingent asset., A contingent asset need not be disclosed in the financial statements. A contingent asset is usually disclosed in the, report of the approving authority (Board of Directors in the case of a company, and the corresponding approving, authority in the case of any other enterprise), if an inflow of economic benefits is probable. Contingent assets are, assessed continually and if it has become virtually certain that an inflow of economic benefits will arise, the asset, and the related income are recognised in the financial statements of the period in which the change occurs., , © The Institute of Chartered Accountants of India

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71, , ACCOUNTING PROCESS, , 5.2, , 1.71, , CONTINGENT LIABILITIES, , The term ‘Contingent liability’ can be defined as, “(a), , a possible obligation that arises from past events and the existence of which will be confirmed only by, the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of, the enterprise; or, , (b), , a present obligation that arises from past events but is not recognised because:, (i), , it is not probable that an outflow of resources embodying economic benefits will be required to, settle the obligation; or, , (ii), , a reliable estimate of the amount of the obligation cannot be made.”, , A contingent liability is a possible obligation arising from past events and may arise in future depending on the, occurrence or non-occurrence of one or more uncertain future events [part (a) of the definition]. A contingent, liability may also be a present obligation that arises from past events [(part (b) of the definition)]., An enterprise should not recognise a contingent liability in balance sheet, however it is required to be disclosed in, the notes to accounts, unless possibility of outflow of a resource embodying economic benefits is remote. These, liabilities are assessed continually to determine whether an outflow of resources embodying economic benefits, has become probable. If it becomes probable that an outflow or future economic benefits will be required for an, item previously dealt with as a contingent liability, a provision is recognised in financial statements of the period, in which the change in probability occurs except in the extremely rare circumstances where no reliable estimate, can be made., , 5.3 DISTINCTION BETWEEN CONTINGENT LIABILITIES AND, LIABILITIES, The distinction between a liability and a contingent liability is generally based on the judgement of the, management. A liability is defined as the present financial obligation of an enterprise, which arises from past, events. The settlement of a liability results in an outflow from the enterprises of resources embodying economic, benefits. On the other hand, in the case of contingent liability, either outflow of resources to settle the obligation, is not probable or the amount expected to be paid to settle the liability cannot be measured with sufficient, reliability. Examples of contingent liabilities are claims against the enterprise not acknowledged as debts,, guarantees given in respect of third parties, liability in respect of bills discounted and statutory liabilities under, dispute etc. In addition to present obligations that are recognized as liabilities in the balance sheet, enterprises are, required to disclose contingent liability in their balance sheets by way of notes., , 5.4 DISTINCTION BETWEEN CONTINGENT LIABILITIES AND, PROVISIONS, Provision means “any amount written off or retained by way of providing for depreciation, renewal or diminution, in the value of assets or retained by way of providing for any known liability of which the amount cannot be, , © The Institute of Chartered Accountants of India

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1.72, , PRINCIPLES AND PRACTICE OF ACCOUNTING, , determined with substantial accuracy”., It is important to know the difference between provisions and contingent liabilities. The distinction between both of, them can be explained as follows:, Provision, , Contingent liability, , (1), , Provision is a present liability of uncertain amount,, which can be measured reliably by using a, substantial degree of estimation., , A Contingent liability is a possible obligation that, may or may not crystallise depending on the, occurrence or non-occurrence of one or more, uncertain future events., , (2), , A provision meets the recognition criteria., , A contingent liability fails to meet the same., , (3), , Provision is recognised when (a) an enterprise, has a present obligation arising from past events;, an outflow of resources embodying economic, benefits is probable, and (b) a reliable estimate, can be made of the amount of the obligation., , Contingent liability includes present obligations, that do not meet the recognition criteria because, either it is not probable that settlement of those, obligations will require outflow of economic, benefits, or the amount cannot be reliably, estimated., , (4), , If the management estimates that it is probable, that the settlement of an obligation will result in, outflow of economic benefits, it recognises a, provision in the balance sheet., , If the management estimates, that it is less likely, that any economic benefit will outflow the firm to, settle the obligation, it discloses the obligation as, a contingent liability., , Let us take an example to understand the distinction between provisions and contingent liabilities. The Central, Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision in the Central Excise Act. The company, goes on an appeal. If the management of the company estimates that it is probable that the company will have to, pay the penalty, it recognises a provision for the liability. On the other hand, if the management anticipates that the, judgement of the appellate authority will be in its favour and it is less likely that the company will have to pay the, penalty, it will disclose the obligation as a contingent liability instead of recognising a provision for the same., , SUMMARY, , , A contingent asset may be defined as a possible asset that arises from past events and whose existence, will be confirmed only after occurrence or non-occurrence of one or more uncertain future events not, wholly within the control of the enterprise., , , , A contingent liability is a possible obligation arising from past events and may arise in future depending, on the occurrence or non-occurrence of one or more uncertain future events., , , , A liability is the present financial obligation of an enterprise, which arises from past events whereas, contingent liability is a possible obligation arising from past events., , , , Provision is a present liability of uncertain amount, which can be measured reliably by using a substantial, degree of estimation whereas Contingent liability is a possible obligation that may or may not crystallise, depending on the occurrence or non-occurrence of one or more uncertain future events., , © The Institute of Chartered Accountants of India

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73, , ACCOUNTING PROCESS, , 1.73, , TEST YOUR KNOWLEDGE, True and False, 1., , A contingent liability need not be disclosed in the financial statements., , 2., , A Provision fails to meet the recognition criteria., , 3., , A claim that an enterprise is pursuing through legal process, where the outcome is uncertain, is a, contingent liability., , 4., , When it is probable that the firm will need to pay off the obligation, this gives rise to Contingent liability., , 5., , Present financial obligation of an enterprise, which arises from past event is termed as contingent, liability., , Multiple Choice Questions, 1., , (i), , (ii), , (iii), , (iv), , (v), , Contingent asset usually arises from unplanned or unexpected events that give rise to, (a), , The possibility of an inflow of economic benefits to the business entity., , (b), , The possibility of an outflow of economic benefits to the business entity., , (c), , Either (a) or (b)., , If an inflow of economic benefits is probable then a contingent asset is disclosed, (a), , In the financial statements., , (b), , In the report of the approving authority (Board of Directors in the case of a company,, and the corresponding approving authority in the case of any other enterprise)., , (c), , In the cash flow statement., , In the case of , either outflow of resources to settle the obligation is not probable or the, amount expected to be paid to settle the liability cannot be measured with sufficient reliability., (a), , Liability, , (c), , Contingent liabilities, , (b), , Provision, , Present liability of uncertain amount, which can be measured reliably by using a substantial, degree of estimation is termed as ., (a), , Provision., , (c), , Contingent liability., , (b), , Liability., , (b), , Not recognised., , In the financial statements, contingent liability is, (a), , Recognised., , (c), , Adjusted., , Theoretical Questions, Differentiate between:, (i), , Provision and Contingent Liability., , (ii), , Liability and Contingent liability., , © The Institute of Chartered Accountants of India

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1.74, , PRINCIPLES AND PRACTICE OF ACCOUNTING, , ANSWERS/HINTS, True and False, 1., , False: A Contingent liability is required to be disclosed unless possibility of outflow of a resource, embodying economic benefits is remote., , 2., , False: A contingent liability fails to meet the recognition criteria., , 3., , False: A claim that an enterprise is pursuing through legal process, where the outcome is uncertain, is, a contingent asset, , 4., , False: When it is probable that the firm will need to pay off the obligation, this gives rise to provision., , 5., , False: Present Financial obligation of an enterprise, which arises from past events is termed as liability,, , Multiple Choice Questions, (i), , (a), , (ii), , (b), , (iii), , (c), , (iv), , (a), , (v), , (b), , Theoretical Questions, 1., , Provision is a present liability of uncertain amount, which can be measured reliably by using a substantial, degree of estimation. On the other hand, a Contingent liability is a possible obligation that may or may not, crystallize depending on the occurrence or non-occurrence of one or more uncertain future events., , 2., , A liability is defined as the present financial obligation of an enterprise, which arises from past events., On the other hand, in the case of contingent liability, either outflow of resources to settle the obligation is, not probable or the amount expected to be paid to settle the liability cannot be measured with sufficient, reliability., , © The Institute of Chartered Accountants of India