Contingent liabilities: the meaning of the concept, features, forms and types

When preparing reports in accordance with IFRS, it is necessary to provide the fullest possible presentation of indicators of the real financial condition of the enterprise. For this, the documents should reflect not only the assessments of already completed operations, but also the facts, the occurrence of which is expected in the future. Information about potential events is extremely important for reporting users. A high degree of uncertainty in the transaction occurs when the accountant needs to reflect the estimated liabilities, contingent liabilities and contingent assets. Further in the article we will deal with the peculiarities of their accounting. So let's get started.

Contingent liabilities

The definition of such obligations is given in IAS 37. According to the standard, conditional is recognized:

A possible liability arising from events that have occurred. Its presence can be confirmed by the occurrence or non-occurrence of events (several or one) in the future. Their occurrence is either vague or not fully controlled by the enterprise.

A contingent liability may also be an existing obligation arising from past events, but not recognized in the statements, because:

• it cannot be established precisely that for its repayment it is necessary to retire any resources that embody economic benefits;
• the amount of the obligation itself cannot be determined with a sufficient degree of certainty.

Simply put, contingent liabilities become due to the fact that they cannot be recognized in the statements, because they do not meet the definition of the obligation or the recognition criteria.

Explanations

According to the first definition above, the existence and consideration of a contingent liability is possible solely by virtue of events that have occurred in the past. To assess it as existing and recognition in the reporting, in the future should occur (or not occur) an event that the company does not manage.

In the second definition, the obligation is already existing, but unrecognized due to the fact that either the outflow of resources during its execution is not probable, or its quantitative indicator does not have a reliable estimate.

Nuances

It should be borne in mind that when preparing consolidated financial statements of a group of companies in the event of a business combination, contingent liabilities are reflected in the balance sheet if possible. In addition, there may be obligations under which the enterprise is jointly and severally liable. Regarding the alleged settlement by other parties, they are also recognized as conditional. Estimated obligations in such situations are recognized as part of the obligation to be settled at the expense of the enterprise’s own resources, if there is the possibility of their reliable assessment.

Probabilistic characteristics

They should be assessed by company managers when deciding whether to recognize contingent liabilities. IFRS focuses on clarifying the meaning of the term “probable”. Its essence boils down to the fact that the necessary event in the future is more likely to come than not. In other words, the probability of an event occurring is above 50%. If in case of execution the outflow of resources is not likely, then the possibility of using the company's own funds is less than 50%. Consider an example.

In the lawsuit, a group of citizens demands compensation for harm caused to health due to environmental pollution caused by the company. In this area, several enterprises are conducting similar activities; accordingly, it is problematic to determine which one is the source of pollution. In this regard, the fault of this company is doubtful. The respondent company denies any guilt, because it takes measures to protect nature. Meanwhile, the true culprit will be established after an analysis of the activities of enterprises. The lawyers of the respondent firm suggest that the court will be able to make a decision in about 2 years. If the case is lost, compensation to the plaintiffs can be from 1 to 30 million rubles.

Taking into account the circumstances, it is impossible to say for sure whether the respondent company has an obligation or not - this will be established by the court. If it is likely that the firm will win the business, then it has a possible obligation and, as follows from the provisions of IFRS, a contingent liability. If it is probable that the company will lose, then the obligation is recognized as existing and, accordingly, the obligation with an indefinite amount and maturity, i.e. an estimated liability.

Compare the rules for the reflection of information. For convenience, we present them in the table.

Subsequently, developments regarding contingent liabilities may not go as expected at the time of reporting, where they were recognized. In this regard, in the following periods, when reporting, it is necessary to analyze and revise the characteristics of the obligation to determine the possibility of disposal of resources that have economic benefits.

If the disposal of future economic benefits is determined as probable, it is necessary to recognize the estimated liability in the statements for the period in which changes in probability are identified. The exception is cases when it is not possible to properly assess the obligation.

Reporting

Special rules for the disclosure of contingent liabilities are contained in IAS 37. In accordance with the standard, an entity shall, at the end of the reporting period, briefly describe the nature of each group of contingent liabilities. This rule is met (if this does not entail unjustified costs for the company) always, except in cases where the disposal of economically viable resources to resolve the obligation is unlikely. In this case, the following should be given:

1. Estimated impact of contingent liabilities on financial performance in accordance with the principles of measurement for the best estimate of the costs required at the end of the period to fulfill an existing obligation. When determining it, it is necessary to take into account risks and sources of uncertainty, the factor of time value of cash (using the discount rate before taxes), future events that could affect the amount of expenses for settlement of the obligation.
2. Signs of uncertainty about the size and amount of a probable disposal of resources.
3. The ability to receive any compensation.

Consider the example related to the last paragraph. A citizen filed a lawsuit against the company with a demand to compensate for the harm to health that arose in connection with the use of its products. The amount of the required compensation is 2 million rubles. The company's managers consulted with lawyers and concluded that the plaintiff’s claims are unfounded, therefore, they consider it obvious that the court will reject the claim and make a decision in favor of the company. However, if the court satisfies the application, the amount of compensation may be no more than 300 thousand rubles.

The IFRS emphasizes that in order to determine which - conditional or evaluation obligations can be distinguished, an analysis of their nature should be carried out. As a result, it may become appropriate to take into account, as one type of obligation, the amounts related to guarantees for various products, but not to take into account money related to legal claims and guarantees. It should also be taken into account that if a contingent and an estimated obligation is determined by one event, the company should provide information so that the relationship between the obligations was disclosed.

Contingent Assets

In accordance with IAS 37, they represent probable assets arising from previous events, the presence of which will be confirmed solely by the occurrence or non-occurrence of future events (several or one), the occurrence of which is uncertain and which are not fully managed by the enterprise.

Contingent assets may arise in connection with unexpected or unplanned events that create the prerequisites for obtaining economic benefits. An example of their appearance, according to IFRS, is the initiation of legal proceedings, the decision on which is uncertain.

Guided by the principle of conservatism, an entity shall not recognize a contingent asset. Otherwise, it is necessary to recognize income, which, quite possibly, will never be realized. However, given the practical evidence of the repayment of receivables (sale of income), an asset cannot be conditional. Therefore, it must be recognized in reporting.

The rules for the reflection of information can be represented as follows.

Reflection in documents

Information is disclosed when an inflow of benefits is likely enough. Under IFRS, contingent liabilities and assets should be described at the end of the period. In addition, in respect of the latter (if feasible), the company provides a calculated estimate of the financial impact on the reporting indicators. They, in turn, are determined in accordance with the principles of measurement for the best assessment of the respective revenues. Information about contingent liabilities and contingent assets should be reflected taking into account sources of uncertainty and risks, the factor of the time value of cash (using the discount rate until the tax is taken into account), upcoming events that may affect the amount of receipts.

Examples

Consider several cases cited in methodological work on contingent liabilities and contingent assets.

The company filed a lawsuit against a competitor in connection with the violation of the latest patent law. The outcome of the application is uncertain. But there is a possibility that the court will oblige the defendant to compensate for the losses incurred by the plaintiff. An entity should disclose contingent assets, since the receipt of economic benefits is probable, but not actually obvious.

If the decision by the court to compensate for the losses by the defendant is actually obvious, the firm needs to recognize the asset. It will not be conditional, since the evidence of profit levels the conditionality of the fact.

If it is probable that a decision will be made in favor of the defendant, the asset should not be recognized. In this case, the receipt of benefits cannot be considered probable, and disclosure is not provided.

Review of contingent asset information

To reflect the changes that occurred after the recognition of assets, the content of the data should be constantly reviewed. When the flow of benefits becomes apparent, the related items are recognized for the period in which the change occurred. If an inflow becomes probable, the company discloses the contingent asset. Reflecting information, it is necessary not to mislead users of reporting on the likelihood of an influx of benefits.

If some information required in accordance with the standard is not presented in the documentation due to the inability to obtain it, this fact must be disclosed in the statements.

The IFRS “Reserves, Contingent Liabilities and Contingent Assets” emphasizes that in rare, exceptional cases there is reason to believe that the reflection of all or individual data may harm the enterprise when resolving disputes with other entities. In such situations, the company is given the right not to disclose information, however, reporting users need to explain the essence of the dispute, indicate the fact of non-disclosure of part of the information and give reasons for this.

Estimated liabilities

All may be considered contingent liabilities. This is because the due date (or amount) is indefinite. At the same time, if the existence is confirmed exclusively in the event of occurrence (non-occurrence) of uncertain upcoming events that are not completely controlled by the enterprise, the concepts of “contingent liability” and “contingent asset” are used. A provision is recognized because there is a high degree of certainty that it will arise:

1. As a result of the enterprise taking actions that indicate (on the basis of statements or cases from practice) that it has assumed certain responsibilities. Consequently, counterparties have a reasonable expectation that obligations will be fulfilled.
2. From the provisions of regulations, treaties, court orders.

As follows from the provisions of the standard, contingent liabilities are not subject to accounting. Estimated liabilities, on the contrary, are reflected in the statements subject to, however, a number of conditions:

1. The company has an obligation that arose in connection with past business events, the fulfillment of which it cannot be avoided.
2. Probably a decrease in the economic benefits of the company to fulfill the obligation.
3. The amount of the obligation can be reasonably estimated.

The specified provisions are present in PBU 8/2010 (paragraph 5).

Valuation

Its value is a key feature by which an estimated obligation differs from a contingent liability. In the PBU mentioned above, there are provisions on valuation. So, according to paragraph 25 of the Rules, if the size of the estimated liability can be reasonably determined, then for a contingent liability it can be very approximate (as a rule, a range of values ​​is given) and is presented in the form of background information in the statements. It should be noted that by virtue of paragraph 9 of the same PBU, in order to comply with IFRS, contingent liabilities also include an estimated liability that exists at the reporting date, but was not recognized due to the inability to reasonably estimate its size or the unlikely decrease in economic benefits.

Now we turn to p. 15 PBU. According to him, the valuation of the estimated liability is characterized by a value that reflects the most reliable estimate of the costs required to repay it. In other words, we are talking about the amount of resources needed to fulfill a duty or transfer a debt to another entity.

Determination criteria

The size of the estimated liability is established on the basis of existing business transactions, experience in fulfilling similar obligations, and opinions of experts and specialists. In addition, the following are taken into account:

1. The consequences of events that occurred after the end date of the period (reporting date).
2. Uncertainties and risks specific to a recognized measurement liability.
3. Upcoming events that could affect the size of the estimated liability. This factor is taken into account if there is a sufficient probability that these events will occur in a future period.

However, the following are not taken into account:

1. Amounts of increase / decrease in income tax.
2. The expected proceeds from the sale of fixed assets, products and other assets related to the estimated liability.
3. Estimated counterclaims or claims against other entities for reimbursement of expenses that may arise at the enterprise when paying off the estimated liability.

Accounting Features

To reflect the estimated liabilities used account. 96. It summarizes information about reserves for future expenses. Depending on the nature of the obligation, its amount refers to expenses incurred in ordinary activities, or to other costs, or is included in the value of the asset for which it is recognized. During the reporting period, when making actual settlements on recognized obligations, the accounting records reflect the amount of expenses incurred in connection with the performance, or the amount of the corresponding payables in correspondence with the account. 96.

Important point

Please note that a liability is recognized as appraisal associated with expenses, the implementation of which is considered the obligation of the organization existing at the reporting date and subject to the conditions established in PBU 8/2010. In essence, this provision is an imperative requirement, not an opportunity to create reserves.

Contingent liabilities and contingent assets: disclosures

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Conclusion

Many believe that an accountant may, at his discretion, apply the rules of PBU 8/2010. However, this is not the case. Recognition and recognition of accounting commitments is the responsibility of any organization. For a legal entity with various duties and burdens, the implementation of the requirements ensures the necessary completeness and proper quality of information about the financial condition. Accordingly, managers can make the right management decisions. After the adoption of the new standard, the accountant has a new task - to receive timely information about all the facts that may result in contingent assets, estimated liabilities and contingent liabilities. For credit institutions, this data is of particular importance.