Contingencies – There are three (general) definitions of a contingency: Contingencies
- An existing situation whose result is unknown or unpredictable, Contingencies
- A possible event that must be prepared for, Contingencies
- A condition that must be satisfied before an action is triggered, an agreement is effected, a contract is performed, a plan is executed, or a provision is enforced. Contingencies
Disclosures should also be made of contingencies, including but not limited to the following: Contingencies
- Contingent losses that are probable and estimable should be accrued, for example, a projected loss on the guaranty of a master lease obligation;
- Contingent losses that are not accrued and yet there is a reasonable possibility that a loss may have been incurred should be disclosed, such as litigation as a defendant;
- Contingent gains are not accrued, but disclosure should be made, while avoiding misleading implications as to the likelihood of the gain, such as litigation as plaintiff;
- Guarantees require disclosure of the liability recognised (fair value of the guarantee at inception), the maximum potential future payments that could be required by the guarantee; and/or
- Contingencies resulting from noncompliance with program requirements which could result in repayment to a funding agency of disallowed costs.
Contingencies are distinct from commitments since there is uncertainty related to the existence of the obligation.
Accounting treatment of contingent losses
Just a short narrative of the accounting treatment of contingent losses to further clarify the judgement needed in distinguishing between commitments and contingencies:
The treatment of contingent losses in financial statements depends upon the likelihood that a future event will confirm that the value of an asset has diminished or a liability incurred at the financial statement date. Contingencies
The amount of a contingent loss should be accrued in the financial statements by a charge to income when both of the following conditions are met:
- It is probable that a future event will confirm that the value of an asset has diminished or a liability incurred at the date of the financial statements.
- The amount of the loss can be reasonably estimated.
If it is probable that a contingency existing at the financial statement date will result in a loss and the loss can be reasonably estimated, accrual of its financial effects is required. This accounting treatment recognises that the probable diminishment of the value of an asset or incurrence of a liability is related to a condition or situation existing at the end of the reporting period and not to the confirming the future event.
A probable loss to an entity may be reduced or avoided by a counterclaim or a claim against a third party (for example, an insurance claim). In such a case, the amount of the probable recovery is an element of the contingent loss and, therefore, should be taken into account in determining the amount to be recognised in the statement of profit or loss.
However, if the probability of success in the related action is not virtually certain, a potential recovery should not be taken into account. The amount of the probable recovery should be presented as a gross amount.
The estimation of the amount of a contingent loss to be accrued in the financial statements may be based on information that provides a range of the amount of loss. When a particular amount within such a range appears to be a better estimate than any other, that amount should be accrued. However, when no amount within the range is indicated as a better estimate than any other, the minimum amount in the range should be accrued.
Accounting treatment of contingent gains
Also, a very short narrative of the accounting treatment of contingent gains to show the exercise of prudence as part of fundamental qualitative characteristic Neutrality in the faithful representation in the Conceptual Framework for Financial Reporting 2018.
Contingent gains usually should not be accrued in financial statements because this accounting treatment could result in the recognition of gains that might never be realised.
An example in real life Financial statements is provided here: Contingencies
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