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Why Contingent Assets Are Not On Balance Sheets

1016 words - 5 pages

Why Contingent assets are not on balance sheets.

It is a key principle for accountants to give a fair and true view of a business to help people that use this information to make more informed decisions. It is important to provide the users, accurate financial information that is as close to the true circumstances as possible and so not to alter the decisions of the users. Accountants produce financial statements that display all of the useful information for all user groups. One of the most common financial statements is the balance sheet. The purpose of the balance sheet is to show the financial position of an entity at a certain point in time by presenting assets, liabilities and ...view middle of the document...

Probable future economic benefits require evidence such as checking for physical existence. Also the reliability of measurement can be reinforced by taking a current asset at cash value or by using depreciation on fixed assets to account for the reduction in value.

Contingent assets are an example of an OBS asset. A definition of contingent assets could be “a possible asset that arises from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity’s control” (RAP 6, 2004) The nature of contingent assets makes it difficult to quantify it precisely; even so an attempt to value it is necessary. A contingent asset does not meet the tests of recognition of an asset; this is because there is too much uncertainty in the future events. Furthermore, it could result in the recognition of profit that is never realised. An example of a contingent asset could be a claim that a business is pursuing through legal processes, where the outcome is unsure.

In a scenario where there is a contingent asset and the inflow of economic benefits is not probable then no asset is recognised and no disclosure is required. However if the inflow of economic benefits is not virtually certain but probable, then no asset is recognised but disclosures of the contingent asset is required on the OBS. The disclosure of the contingent asset on the OBS provides the structure for reporting the contingent asset on the balance sheet when the contingent asset begins to show potential tangible benefit.

According to the International Accounting Standards (IAS) this is the rule that is followed. Nevertheless, if the value of economic benefits is measurable and it is probable that economic benefits will flow, then it would be logical to suggest that in this scenario the contingent asset will be recognised as an asset and be included in the balance sheet. However, this will be going against prudence....

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