Contingent Liability definition - What is meant by the term Contingent Liability They would advise the firm not to make any provision of a contingent liability. From the definition of liabilities, three main concepts are highlighted, namely: . The difference between provisions and contingent liabilities is illustrated by the. and measurement bases are applied to provisions and contingent liabilities and that sufficient Where a restructuring meets the definition of a practice, custom and a desire to maintain good business relations or act in an equitable manner.
Here, the amount received from the new loan is used to pay off other debts. Debt consolidation is used by consumers to pay off a small debt in one go by taking one big loan. By doing this they save on interest as well as the finance cost of the small loan owed by them. The borrower would now have to make one payment instead of making multiple payments to other creditors. Debt consolidation can happen on debts which are not tied up to an asset. Education loan, amount owed on credit card, personal loan are some examples of unsecured loans which can come under debt consolidation.
There are some steps which borrowers should follow when they are planning to consolidate their debt. Identify your debt s obligations, the total amount that you owe the lenders, time period or tenure, apply for a consolidation loan, once you receive the loan pay off other debts, stick to the payment cycle of the consolidated loan. Let's understand the concept with the help of an example.
For instance you have a loan obligation of Rs 3,00, which includes a two-year loan of Rs 1,00, with an interest rate of 12 per cent. There is another loan of Rs 2,00, which carries an interest rate of 10 per cent annually. The monthly payment for both the loans comes out to be around Rs which includes a payment of Rs from loan 1, and another payment of Rs from loan 2. The borrower can reach out to debt Consolidation Company to understand the structure.
They might be able to lower the easy monthly instalments or EMIs to around Rsand consolidate both the loans into one. However, in the process the tenure was increased to pay off the loan. A contingent liability is defined as a liability which may arise depending on the outcome of a specific event.
It is a possible obligation which may or may not arise depending on how a future event unfolds. A contingent liability is recorded when it can be estimated, else it should be disclosed. A contingent liability is a liability or a potential loss that may occur in the future depending on the outcome of a specific event. Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is virtually certain to be enacted.
Differences in circumstances surrounding enactment usually make it impossible to specify a single event that would make the enactment of a law virtually certain. In many cases it will be impossible to be virtually certain of the enactment of a law until it is enacted.
For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation.
For the purpose of this Standard4an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.
Where it is not probable that a present obligation exists, an enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote see paragraph Where there are a number of similar obligations e.
Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is recognised if the other recognition criteria are met. Reliable Estimate of the Obligation The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature involve a greater degree of estimation than most other items.
Except in extremely rare cases, an enterprise will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is reliable to use in recognising a provision. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability see paragraph An enterprise should not recognise a contingent liability.
A contingent liability is disclosed, as required by paragraph 68, unless the possibility of an outflow of resources embodying economic benefits is remote. Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability.
The enterprise recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made see paragraph Contingent liabilities may develop in a way not initially expected.
AS 29 – Provisions, Contingent Liabilities and Contingent Assets
Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in accordance with paragraph 14 in the financial statements of the period in which the change in probability occurs except in the extremely rare circumstances where no reliable estimate can be made.
An enterprise should not recognise a contingent asset. Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the enterprise.
An example is a claim that an enterprise is pursuing through legal processes, where the outcome is uncertain. Contingent assets are not recognised in financial statements since this may result in the recognition of income that may never be realised.
However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate. A contingent asset is not disclosed in the financial statements. It is usually disclosed in the report of the approving authority Board of Directors in the case of a company, and, the corresponding approving authority in the case of any other enterprisewhere an inflow of economic benefits is probable.
Contingent assets are assessed continually and if it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognised in the financial statements of the period in which the change occurs. Measurement Best Estimate The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The amount of a provision should not be discounted to its present value except in case of decommissioning, restoration and similar liabilities that are recognised as cost of Property, Plant and Equipment.
The discount rate or rates should be a pre-tax rate or rates that reflect s current market assessments of the time value of money and the risks specific to the liability. The discount rate s should not reflect risks for which future cash flow estimates have been adjusted. Periodic unwinding of discount should be recognised in the statement of profit and loss. The estimates of outcome and financial effect are determined by the judgment of the management of the enterprise, supplemented by experience of similar transactions and, in some cases, reports from independent experts.
The provision is measured before tax; the tax consequences of the provision, and changes in it, are dealt with under AS 22, Accounting for Taxes on Income. Risks and Uncertainties The risks and uncertainties that inevitably surround many events and circumstances should be taken into account in reaching the best estimate of a provision.
Risk describes variability of outcome. A risk adjustment may increase the amount at which a liability is measured. Caution is needed in making judgments under conditions of uncertainty, so that income or assets are not overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities. For example, if the projected costs of a particularly adverse outcome are estimated on a prudent basis, that outcome is not then deliberately treated as more probable than is realistically the case.
Care is needed to avoid duplicating adjustments for risk and uncertainty with consequent overstatement of a provision. Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph 67 b. Future events that may affect the amount required to settle an obligation should be reflected in the amount of a provision where there is sufficient objective evidence that they will occur. Expected future events may be particularly important in measuring provisions.
For example, an enterprise may believe that the cost of cleaning up a site at the end of its life will be reduced by future changes in technology.
The amount recognised reflects a reasonable expectation of technically qualified, objective observers, taking account of all available evidence as to the technology that will be available at the time of the clean-up.
Thus, it is appropriate to include, for example, expected cost reductions associated with increased experience in applying existing technology or the expected cost of applying existing technology to a larger or more complex clean-up operation than has previously been carried out. However, an enterprise does not anticipate the development of a completely new technology for cleaning up unless it is supported by sufficient objective evidence. The effect of possible new legislation is taken into consideration in measuring an existing obligation when sufficient objective evidence exists that the legislation is virtually certain to be enacted.
AS 29 – Provisions, Contingent Liabilities and Contingent Assets
The variety of circumstances that arise in practice usually makes it impossible to specify a single event that will provide sufficient, objective evidence in every case. Evidence is required both of what legislation will demand and of whether it is virtually certain to be enacted and implemented in due course. In many cases sufficient objective evidence will not exist until the new legislation is enacted. Expected Disposal of Assets Gains from the expected disposal of assets should not be taken into account in measuring a provision.
Gains on the expected disposal of assets are not taken into account in measuring a provision, even if the expected disposal is closely linked to the event giving rise to the provision. Instead, an enterprise recognises gains on expected disposals of assets at the time specified by the Accounting Standard dealing with the assets concerned.
Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation.
The reimbursement should be treated as a separate asset. The amount recognised for the reimbursement should not exceed the amount of the provision. In the statement of profit and loss, the expense relating to a provision may be presented net of the amount recognised for a reimbursement. The other party may either reimburse amounts paid by the enterprise or pay the amounts directly. In most cases, the enterprise will remain liable for the whole of the amount in question so that the enterprise would have to settle the full amount if the third party failed to pay for any reason.
In this situation, a provision is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is recognised when it is virtually certain that reimbursement will be received if the enterprise settles the liability. In some cases, the enterprise will not be liable for the costs in question if the third party fails to pay. In such a case, the enterprise has no liability for those costs and they are not included in the provision.
As noted in paragraph 28, an obligation for which an enterprise is jointly and severally liable is a contingent liability to the extent that it is expected that the obligation will be settled by the other parties. Changes in Provisions Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate.
If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed. Use of Provisions A provision should be used only for expenditures for which the provision was originally recognised.
Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.