Question

3. Cite and explain GAAP’s statement about gain contingencies (should they be shown on the financial statements and/or should they be disclosed in the notes to the financial statements).

Answer 1

Ans -

Definition - A contingent asset is a potential economic benefit that is dependent on future events out of a company’s control. Not knowing for certain whether these gains will materialize, or being able to determine their precise economic value. means these assets cannot be recorded on the Balance sheet . However, they can be reported in the accompanying notes of Financial statements provided that certain conditions are met. A contingent asset is also known as a potential asset.

Gain contingencies, or possible occurrences of a gain on a claim or obligation involving the entity, are reported when realized (earned).

GAAP Statement on it -

a) If a specific event that can cause the gain occurs, and the gain is realized, then the gain is accrued for and reported in the financial statements. It is also disclosed in the notes section.

b) The materiality concept states that if a gain contingency, that remains unrealized, affects the economic decision of statement users, it should be disclosed in the notes.

c) Probable and quantifiable gains are not accrued for reporting purposes, but they can be disclosed in the notes to the financial statements if they are material. If the gain is not probable or reasonably estimated, but could materially effect financial statements, the gain is disclosed in a note.

d) Following conservative constraints for a gain contingency, only a realized gain should be accrued for and disclosed on an income statement.

Notes -

i) unrealized means : Not realized; possible to obtain, yet not obtained.

ii) Contingency means : A possibility; something which may or may not happen. This also can mean a chance occurrence, especially in, unexpected expenses

Examples of Contingent Assets

A company involved in a lawsuit with the expectation to receive compensation has a contingent asset because the outcome of the case is not yet known and the dollar amount is yet to be determined.

Let’s say Company XUZ has filed a lawsuit against Company AYZ for infringing a patent. If there is a decent chance that Company XUZ will win the case, it has a contingent asset. This potential asset will generally be disclosed in its financial statement, but not recorded as an asset until the lawsuit is settled.

Based on this same example, Company AYZ would need to disclose a potential contingent liability in its notes and then later record it in its accounts, should it lose the lawsuit and be ordered to pay damages.

Contingent assets also crop up when companies expect to receive money through the use of a warranty. Other examples include benefits to be received from an estate or other court settlement. Anticipated mergers and acquisitions are to be disclosed in the financial statements.