IAS 37 Provisions, contingent liabilities and contingent assets

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Even if the country that Rey Co operates in has no legal regulations forcing them to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history. This is where a company establishes an expectation through an established course of past practice. For some ACCA candidates, specific IFRS® standards are more favoured than others. However, IAS 37 is often a key standard in FR exams and candidates must be prepared to demonstrate application of the criteria.

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• It does not make any sense to immediately realize a contingent liability – immediate realization signifies the financial obligation has occurred with certainty.
• Pending litigation involves legal claims against the business that may be resolved at a future point in time.
• However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery.
• Assume that Sierra Sports is sued by one of the customers who purchased the faulty soccer goals.
• The journal entry for a contingent liability—as illustrated below—is a credit entry to the contingent warranty liability account and a debit entry to the warranty expense account.
• Some examples of contingent liabilities include pending litigation (legal action), warranties, customer insurance claims, and bankruptcy.

This does not meet the likelihood requirement, and the possibility of actualization is minimal. In this situation, no journal entry or note disclosure in financial statements is necessary. Now assume that a lawsuit liability is possible but not probable and the dollar amount is estimated to be $2 million. Under these circumstances, the company discloses the contingent liability in the footnotes of the financial statements. If the firm determines that the likelihood of the liability occurring is remote, the company does not need to disclose the potential liability. Ifit is determined that too much is being set aside in the allowance,then future annual warranty expenses can be adjusted downward.

• The liability would be considered a short-term liability if the expected settlement date is within one year of the balance sheet date.
• They estimate the potential legal settlement to be between $1 million and $2 million– with the most likely settlement amount being $1.25 million.
• IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets.
• The measurement requirement refers to the company’s ability to reasonably estimate the amount of loss.
• The journal entry would include a debit to legal expense for $1.25 million and a credit to an accrued liability account for $1.25 million.

What are some examples of contingent liabilities?

For example, Sierra Sports has a one-year warranty on partrepairs and replacements for a soccer goal they sell. Sierra Sports notices that some of its soccergoals have rusted screws that require replacement, but they havealready sold goals with this problem to customers. There is aprobability that someone who purchased the soccer goal may bring itin to have the screws replaced. Not only does the contingentliability meet the probability requirement, it also meets themeasurement requirement. A provision is measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time.

2 Recognition of provisions

The amount that the company should accrue is either the most accurate estimate within a range or– if no amount within the potential range is more likely than the others– the minimum amount of the range. A contingent liability is a potential obligation that depends on the occurrence or non-occurrence of one or more events in the future. If the event occurs, the company a contingent liability that is probable and for which the dollar amount can be estimated should be may be required to make a payment; if it does not occur, the company will not be required to make a payment. An automobile guarantee or other product warranties are examples of contingent liabilities that, are usually recorded on a company’s books.

Contingent Liabilities: Explanation

Similarly, the guidance in ASC 460 on accounting for guarantee liabilities, which has existed for two decades, is often difficult to apply because the determination of whether an arrangement constitutes a guarantee is complex. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. Therefore, the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

If only one of the conditions is met, the liability must be disclosed in the footnotes section of the financial statements to abide by the full disclosure principle of accrual accounting. Some common examples of contingent liabilities are pending lawsuits and product warranties because each scenario is characterized by uncertainty, yet still poses a credible threat. The recognition of contingent liabilities on the financial statements (and footnotes) is to present investors, lenders, and others with reliable financial statements that contain accurate, conservative information.

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Accrual for Contingent Liabilities

• In May 2020 the Board issued Onerous Contracts—Cost of Fulfilling a Contract.
• Consequently, the provision will increase each year until it becomes $20m at the end of the asset’s 25-year useful life.
• Liquidity and solvency are measures of a company’s ability to pay debts as they come due.
• These are questions businesses must ask themselves when exploring contingencies and their effect on liabilities.

Similar to the concept of a contingent liability is the concept of a contingent asset. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. Again, a description of the event should be recorded in addition to any potential amount. The key difference is that a contingent asset is only disclosed if there is a probable future inflow, rather than a possible one. The table below shows the treatment for an entity depending on the likelihood of an item happening. Google, a subsidiary of Alphabet Inc., https://x.com/BooksTimeInc has expanded from a search engine to a global brand with a variety of product and service offerings.

• Now assume that a lawsuit liability is possible but not probable and the dollar amount is estimated to be $2 million.
• Both represent possible losses and both depend on some uncertain future event.
• Following are the necessary journal entries to record the expense in 2019 and the repairs in 2020.
• IFRS Sustainability Standards are developed to enhance investor-company dialogue so that investors receive decision-useful, globally comparable sustainability-related disclosures that meet their information needs.
• For a financial figure to be reasonably estimated, it could be based on past experience or industry standards (see Figure 12.9).

Application of Likelihood of Occurrence Requirement

IFRS Accounting Standards are, in effect, a global accounting language—companies in more than 140 jurisdictions are required to use them when reporting on their financial health. On that note, a company could record a contingent liability and prepare for the worst-case scenario, only for the outcome to still be favorable. The factor of uncertainty, where the outcome is out of the company’s control for the most part, is one of the core attributes of contingent liabilities.