Two of very few things, a CA student would easily identify and define during the student days are the Contingent Assets and Contingent Liabilities. This is because, it is pretty straight forward and does not require you to squeeze your brain to get an answer. At the same time, it does not appear too frequently in examinations, but when it does, you are sure to pocket few marks.
Let's go ahead and define Contingent Assets and Contingent Liabilities
Note: Contingent means subject to chance which further means unpredictable.
A possible asset arising from past events and their existence will be confirmed only after occurrence or non-occurrence of one or more uncertain events.
Now, if you break down the definition, it says the following about Contingent Assets
A possible asset: It is only a possible asset and there is no surety that the asset will be created.
The definition also says that the asset will be generated as a result of some past events. If the assets are not related any past event, then they not called as a Contingent Asset.
Then it says, existence of such asset will be confirmed only in the future based on happening or non-happening of another event. which is something that cannot be determined now, which further means those events are not very certain or within the company's control.
From the definition, it is very clear that contingent assets are assets, which might arise in the future and which is not well within the control of the enterprise.
Example could be an insurance claim which the entity is expecting to receive in future but is not sure of.
ACCOUNTING FOR OR RECOGNIZING CONTINGENT ASSETS:
As a prudent accountant, you must not recognize or account for a contingent asset, as it is an uncertain asset. It is also not required for you to disclose it in the Financial Statements. Usually, the details of any such contingent assets are disclosed in the Board of Director's Report only.
WHEN CONTINGENT ASSET BECOMES CERTAIN:
As soon as you come to know or become certain about the contingent assets and that you will be getting all benefits out of it, you can recognize or account it in the Financial Statements.
A Possible obligation arising from past events and may arise in future depending on the occurrence or non-occurrence of one or more uncertain events.
By breaking down the definition, it is clear that, even this is a possible obligation and there is no surety that it will arise in future.
It arises from past events. It is important to note here that the contingent liability arise, as a result of past events and will become a confirmed liability depending on future events, which may or may not occur. Hence, the contingent liability becoming a confirmed liability is uncertain and also not within the control of the entity.
ACCOUNTING FOR OR RECOGNIZING CONTINGENT LIABILITY
Contingent liabilities are not recognized or accounted for unless it becomes certain that the liability has occurred and the amount of liability is known, just like contingent assets. However, it has to be disclosed in the Financial Statements unlike contingent assets, which are disclosed in the Board of Director's Report.
Unless the contingent liability or outflow relating to the contingent liability becomes very remote, it should be disclosed in the Financial Statements about the existence of such contingent liability with additional details as set out in the Ind AS 37 or IAS 37. For in-depth study on Contingent Liabilities, Contingent Assets and Provisions, Check out this link.
If it becomes probable that the contingent liability will result in outflow of economic benefit, ( meaning: that is outflow of money or items that can be quantified in terms of money), then a provision is made for the contingent liability.
If you notice in the above explanation, an accountant has to be clear in identifying Contingent Assets, Contingent Liabilities and Provisions. To learn more about when Contingent Liabilities become provisions, check out this link here.
Solution: In the above case, since it is 80% possible that the company will lose the case and would have to pay Rs.5 Lakhs, Finger Foods Pvt Ltd, should disclose this as a Contingent Liability in the Financial Statements.