A contingent asset is a possible asset arising from past events whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the business. Contingent assets are the mirror image of contingent liabilities and are governed by the same section of the accounting standards.
Under FRS 102 (Section 21), contingent assets are never recognised on the balance sheet. They are disclosed in the notes to the financial statements only when an inflow of economic benefits is probable.
Recognition and Disclosure Rules
The treatment of a contingent asset depends on the probability of the inflow materialising:
| Probability of Inflow | Treatment |
|---|---|
| Virtually certain | Not a contingent asset – recognise as an asset on the balance sheet |
| Probable (more likely than not) | Disclose in the notes to the financial statements |
| Possible (but not probable) | No disclosure required |
| Remote | No disclosure required |
The key distinction from contingent liabilities is the higher threshold for disclosure. Contingent liabilities are disclosed when the outflow is “possible,” but contingent assets are disclosed only when the inflow is “probable.” This asymmetry reflects the prudence principle – accounting standards are cautious about recognising gains but prompt in recognising losses.
Common Examples
| Example | Nature of Contingency |
|---|---|
| Insurance claim | The company has submitted a claim to its insurer following a fire. The insurer has acknowledged the claim but not yet confirmed the payout amount. |
| Legal action against a third party | The company is suing a former supplier for breach of contract. Legal counsel advises the claim is likely to succeed, but the outcome depends on the court’s decision. |
| Tax refund claim | The company has lodged a claim with HMRC for overpaid tax. HMRC has acknowledged the claim but not yet issued the refund. |
| Government grant application | The company has applied for a grant and meets all the criteria, but formal approval has not yet been received. |
| Warranty claim against a supplier | The company is claiming against a supplier’s warranty for defective goods delivered. |
| Compensation from a regulator | A regulatory body is expected to compensate the company for costs incurred complying with a subsequently withdrawn regulation. |
Contingent Assets Under FRS 102
FRS 102 (Section 21) sets out a clear framework:
Never Recognise
A contingent asset is not recognised in the financial statements because doing so could result in recognising income that may never be received. The standard states:
- Do not recognise contingent assets as assets
- Do not recognise contingent assets as income in the income statement
- Wait until the inflow is virtually certain before recognition
When to Disclose
Disclosure in the notes is required when an inflow of economic benefits is probable. The disclosure should include:
- A brief description of the nature of the contingent asset
- Where practicable, an estimate of its financial effect
If it is not practicable to provide an estimate, that fact must be stated.
When Disclosure Is Not Required
If the possibility of an inflow is only possible or remote, no disclosure is needed.
Example Note Disclosure
When disclosure is required, it might appear as follows in the notes to the accounts:
Contingent assets
The company is pursuing a claim against a former supplier for damages of £250,000 arising from the supply of defective raw materials. Legal counsel has advised that the claim is likely to succeed, but the final outcome and amount recoverable remain uncertain. No asset has been recognised in these accounts.
Contingent Assets Versus Recognised Assets
The boundary between a contingent asset and a recognised asset depends on the degree of certainty:
| Degree of Certainty | Treatment |
|---|---|
| Virtually certain (asset will be received) | Recognise on the balance sheet |
| Probable (more likely than not) | Disclose as contingent asset in notes |
| Possible | No action required |
| Remote | No action required |
When circumstances change and the inflow becomes virtually certain, the asset is no longer contingent. At that point, it is recognised on the balance sheet – typically as a receivable or as income.
Transition from Contingent to Recognised
A company is claiming £100,000 from its insurer. The progression might be:
| Stage | Assessment | Accounting Treatment |
|---|---|---|
| Claim submitted | Possible | No disclosure |
| Insurer acknowledges validity of claim | Probable | Disclose as contingent asset |
| Insurer confirms payout of £95,000 | Virtually certain | Recognise £95,000 as a receivable and income |
| Cash received | Certain | Debit bank, credit receivable |
Contingent Assets and Contingent Liabilities Compared
| Feature | Contingent Asset | Contingent Liability |
|---|---|---|
| Nature | Possible inflow of economic benefits | Possible outflow of economic benefits |
| Recognition on balance sheet | Never (until virtually certain) | Never (until probable and measurable, then recognised as a provision) |
| Disclosure threshold | Probable | Possible |
| Prudence | Higher bar for recognition reflects caution about recognising gains | Lower bar for disclosure reflects caution about understating risks |
This asymmetry means that a company might disclose a contingent liability relating to the same legal dispute that the counterparty discloses as a contingent asset. The same event produces different accounting treatments for the two parties.
Contingent Assets in Business Combinations
When a company acquires another business, the identifiable assets of the acquired entity must be recognised at fair value. Under FRS 102, contingent assets of the acquired entity are not recognised separately in a business combination because they do not meet the definition of an identifiable asset (their existence is uncertain).
This contrasts with contingent liabilities, which are recognised at fair value in a business combination if they can be measured reliably.
Contingent Assets and the Audit
Auditors consider contingent assets as part of their assessment of the completeness and accuracy of the financial statements:
- Inquiry of management about known claims, disputes, and expected recoveries
- Review of legal correspondence for evidence of claims being pursued
- Examination of insurance policies for potential recoveries
- Assessment of disclosure to ensure it is complete and not misleading
Auditors must also ensure that no contingent asset has been improperly recognised as a balance sheet asset. The risk of overstatement is a key audit concern.
Contingent Assets and Corporation Tax
A contingent asset has no corporation tax impact until it is recognised. Tax implications arise when:
- The asset becomes virtually certain and is recognised as income – it is taxable in the period of recognition
- An insurance recovery is received – it may be taxable or may reduce a previously deducted loss
- A legal settlement is received – the tax treatment depends on whether the original cost was a trading expense
Practical Considerations
Maintaining a Register
Businesses should maintain a schedule of contingent assets, reviewed at least at each reporting date:
| Field | Purpose |
|---|---|
| Description | Nature of the possible asset |
| Estimated amount | Best estimate of the potential inflow |
| Probability | Assessment of likelihood (probable/possible/remote) |
| Trigger event | What would confirm the asset |
| Expected timing | When the outcome is likely to be determined |
Avoiding Premature Recognition
The temptation to recognise a contingent asset prematurely – particularly when the company needs to present a strong financial position to lenders or investors – must be resisted. Premature recognition overstates assets and income, potentially misleading users of the financial statements and breaching the requirements of FRS 102 and the Companies Act 2006.
The guiding principle is straightforward: do not recognise income that may never be received. Disclose the possibility when it is probable, and recognise it only when it is virtually certain.