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Contingent Assets and Contingent Liabilities

"Maybe assets, maybe liabilities - it depends on future events."

Contingent items are possible assets or liabilities whose existence depends on the occurrence or non-occurrence of uncertain future events NOT wholly within the control of the entity.

What is Contingent Liability?

Definition (AS-29): A possible obligation arising from past events whose existence will be confirmed only by occurrence/non-occurrence of uncertain future events.

Simple Meaning: "If this happens, we'll have to pay."

Common Examples

✅ Lawsuits pending against the company
✅ Guarantees given for others' loans
✅ Bills discounted (if dishonored, we pay)
✅ Claims not acknowledged by company
✅ Disputed tax demands

What is Contingent Asset?

Definition: A possible asset arising from past events whose existence will be confirmed only by occurrence/non-occurrence of uncertain future events.

Simple Meaning: "If this happens, we'll receive money."

Common Examples

✅ Lawsuits filed by the company (claiming damages)
✅ Insurance claims pending approval
✅ Tax refunds under dispute
✅ Guarantees received from customers

Accounting Treatment

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Key Rule (Conservatism):

  • Contingent Liabilities: Disclose (even if remote chance)
  • Contingent Assets: Disclose ONLY if virtually certain

Contingent vs Provision

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When does Contingent Liability become Provision?

  • When probability increases from "possible" to "probable"
  • When amount can be reliably estimated

Detailed Examples

Example 1: Lawsuit Against Company

Scenario: ABC Ltd is facing a lawsuit for ₹50 Lakhs. Lawyers say outcome uncertain.

Treatment:

  • NOT recorded in Balance Sheet (contingent)
  • Disclosed in Notes: "Company is facing a lawsuit for ₹50 Lakhs. The outcome is uncertain."

If lawyers later say "probable loss":

  • Record as Provision for ₹50 Lakhs
  • Entry: 
    Provision for Lawsuit A/c    Dr.    ₹50,00,000
    To Provision for Lawsuit A/c       ₹50,00,000

Example 2: Guarantee Given

Scenario: XYZ Ltd guaranteed a loan of ₹1 Crore for its subsidiary.

Treatment:

  • NOT recorded as liability (contingent)
  • Disclosed in Notes: "Company has guaranteed bank loan of ₹1 Crore for subsidiary XYZ."

If subsidiary defaults:

  • Company must pay → becomes actual liability
  • Record as Liability and pay

Example 3: Bills Discounted

Scenario: Company discounted bills receivable worth ₹10 Lakhs with bank.

Treatment:

  • NOT shown as liability (contingent)
  • Disclosed in Notes: "Bills discounted with bank: ₹10 Lakhs"

If bill gets dishonored:

  • Company must pay bank → actual liability
  • Debit: Debtors, Credit: Bank

Real-World Case Study

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Disclosure Requirements (AS-29)

For each class of Contingent Liability:

  • Nature of contingency
  • Estimated financial effect (or state cannot be estimated)
  • Uncertainties affecting amount/timing

For Contingent Assets:

  • Disclose ONLY if inflow of economic benefits is probable
  • Brief description of nature
  • Estimated financial effect (if possible)

Decision Tree

Ask these questions:

  1. Is there a present obligation from past event?

    • NO → Contingent Liability (disclose)
    • YES → Go to Q2

  2. Is outflow of resources probable?

    • NO → Contingent Liability (disclose)
    • YES → Go to Q3

  3. Can amount be reliably estimated?

    • NO → Contingent Liability (disclose)
    • YES → Provision (record in B/S)

Common Exam Questions

Q: Pending lawsuit for ₹10 Lakhs. How to treat?
A: Contingent Liability - Disclose in Notes, do NOT record in B/S.

Q: Company guaranteed loan ₹5 Lakhs for director. Treatment?
A: Contingent Liability - Disclosed in Notes as "Guarantees given: ₹5 Lakhs"

Q: Insurance claim of ₹2 Lakhs virtually certain to be received. Treatment?
A: Contingent Asset - Disclose in Notes (only if virtually certain)

Quiz: Contingent Items

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