Contingent assets

What it means

Contingent assets are possible claims or other assets whose existence will be confirmed only by the occurrence or non-occurrence of an uncertain future event not wholly within the company's control. Typical examples are a damages lawsuit the company has filed but the court has not yet decided, an insurance claim under investigation, or an expected refund from a customs dispute.

Contingent assets are not recognised in the balance sheet. This follows from the prudence principle: the accounts should not show gains that are not yet certain. If an inflow of economic benefits is probable, the company describes the contingent asset in the notes so that readers know about the potential benefit.

The opposite applies to contingent liabilities. If it is probable the company will have to pay, it creates a provision and recognises the expense now. The asymmetry is deliberate: losses are recorded earlier, gains only once confirmed. Under IFRS a contingent asset is recognised only when the inflow is virtually certain.

How it works in practice

In practice they are most often lawsuits where the company is the claimant, insurance claims, warranty claims against suppliers and claims for refunds of taxes or duties. When preparing the financial statements, the likelihood of success should be assessed with a lawyer to decide whether and how the claim is described in the notes.

Once the uncertainty is removed, for example a court rules finally in the company's favour or an insurer accepts the claim, the contingent asset stops being contingent and a receivable and income are recognised. What matters is the moment the claim becomes virtually certain, not the moment the money reaches the account.

In acquisitions or credit assessments contingent assets are treated with caution. Investors usually do not include them fully in the price but treat them as a possible bonus, sometimes agreeing that the seller receives an earn-out if the claim succeeds. A precise description in the notes helps in negotiations.

What to watch out for

It is a mistake to book a receivable from an unwon dispute just because the company is convinced it is right. Doing so overstates assets and profit, the auditor will object, and corrections are needed if the case is lost. It is equally wrong to omit from the notes a significant claim that readers of the statements should know about.

Consider the tax angle too. Income from a contingent asset is taxed only once it is recognised. If the company recognises income prematurely, it pays tax on income it may never receive. With uncertain claims, prudence therefore also pays off in cash flow terms.