ICAI Notes- Unit 4: Contingent Assets and Contingent Liabilities | Principles and Practice of Accounting - CA Foundation PDF Download

 Page 1


  ACCOUNTING 
1.74 
1.74 
LEARNING OUTCOMES 
UNIT – 4 CONTINGENT ASSETS AND CONTINGENT 
LIABILITES 
 
After studying this Unit, you will be able to:
 
? Understand the meaning of the terms ‘Contingent Assets’ and 
‘Contingent Liabilities’. 
? Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’ 
 
 
 
 
 
 
 
 
 
 
 4.1  CONTINGENT ASSET 
A contingent asset may be defined as a possible asset that arises from past events and whose 
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain 
future events not wholly within the control of the enterprise. It usually arises from unplanned 
or unexpected events that give rise   to the possibility of an inflow of economic benefits to 
the business entity. For example, a claim that an enterprise is pursuing through legal process, 
where the outcome is uncertain, is a contingent asset. 
•A possible asset arises from past events and their
existence will be confirmed only after occurrence
or non-occurrence of one or more uncertain
future events.
Contingent Asset
•A possible obligation arising from past events and 
may arise in future depending on the occurrence 
or non-occurrence of one or more uncertain 
future events.
Contingent Liability
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
Page 2


  ACCOUNTING 
1.74 
1.74 
LEARNING OUTCOMES 
UNIT – 4 CONTINGENT ASSETS AND CONTINGENT 
LIABILITES 
 
After studying this Unit, you will be able to:
 
? Understand the meaning of the terms ‘Contingent Assets’ and 
‘Contingent Liabilities’. 
? Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’ 
 
 
 
 
 
 
 
 
 
 
 4.1  CONTINGENT ASSET 
A contingent asset may be defined as a possible asset that arises from past events and whose 
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain 
future events not wholly within the control of the enterprise. It usually arises from unplanned 
or unexpected events that give rise   to the possibility of an inflow of economic benefits to 
the business entity. For example, a claim that an enterprise is pursuing through legal process, 
where the outcome is uncertain, is a contingent asset. 
•A possible asset arises from past events and their
existence will be confirmed only after occurrence
or non-occurrence of one or more uncertain
future events.
Contingent Asset
•A possible obligation arising from past events and 
may arise in future depending on the occurrence 
or non-occurrence of one or more uncertain 
future events.
Contingent Liability
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
1.75
THEORETICAL FRAMEWORK 
 
As per the concept of prudence as well as the present accounting standards, an enterprise 
should not recognise a contingent asset. These assets are uncertain and may arise from a 
claim which an enterprise pursues through a legal proceeding. There is uncertainty in realisation 
of claim. It is possible that recognition of contingent assets may result in recognition of income 
that may never be realised. However, when the realisation of income is virtually certain, then 
the related asset no longer remains as contingent asset. 
A contingent asset need not be disclosed in the financial statements. A contingent asset 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 enterprise), if 
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. 
 4.2  CONTINGENT LIABILITIES 
The term ‘Contingent liability’ can be defined as 
“(a)  a possible obligation that arises from past events and the existence of which will be 
confirmed only by the occurrence or non-occurrence of one or more uncertain future 
events not wholly within the control of the enterprise; or 
(b) a present obligation that arises from past events but is not recognised because: 
(i) it is not probable that an outflow of resources embodying economic benefits 
will be required to settle the obligation; or 
(ii) a reliable estimate of the amount of the obligation cannot be made.” 
For example- Mr. X sells a machine to Mr. Y. Any damages incurred by Mr. Y while using the 
machine need to be compensated by Mr. X. A few days later from the date of sale of machine, 
Mr. X received a notice from Mr. Y who is claiming damages of ` 20 lac. The notice mentioned 
that a worker met with an accident during the use of the machine and is required to be 
compensated. 
The receipt of this notice does not suggest that Mr. X is liable to pay the amount, although 
this needs to be investigated and confirmed, as whether the damage arose due to any defect 
in the machine or it is due to negligence while operating the machine. Although, the receipt 
of the notice results into an event which requires recognition of a contingent liability since 
there is a possible obligation, and that can only be confirmed in future. 
Taking another example let us assume Mr. AB sells cars to its customers. One of the cars 
caught fire due to malfunctioning of a faulty part during the test drive by one of the 
customers. The customer has filed a court case seeking a claim of ` 50 lac due to the incidence. 
© The Institute of Chartered Accountants of India
Page 3


  ACCOUNTING 
1.74 
1.74 
LEARNING OUTCOMES 
UNIT – 4 CONTINGENT ASSETS AND CONTINGENT 
LIABILITES 
 
After studying this Unit, you will be able to:
 
? Understand the meaning of the terms ‘Contingent Assets’ and 
‘Contingent Liabilities’. 
? Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’ 
 
 
 
 
 
 
 
 
 
 
 4.1  CONTINGENT ASSET 
A contingent asset may be defined as a possible asset that arises from past events and whose 
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain 
future events not wholly within the control of the enterprise. It usually arises from unplanned 
or unexpected events that give rise   to the possibility of an inflow of economic benefits to 
the business entity. For example, a claim that an enterprise is pursuing through legal process, 
where the outcome is uncertain, is a contingent asset. 
•A possible asset arises from past events and their
existence will be confirmed only after occurrence
or non-occurrence of one or more uncertain
future events.
Contingent Asset
•A possible obligation arising from past events and 
may arise in future depending on the occurrence 
or non-occurrence of one or more uncertain 
future events.
Contingent Liability
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
1.75
THEORETICAL FRAMEWORK 
 
As per the concept of prudence as well as the present accounting standards, an enterprise 
should not recognise a contingent asset. These assets are uncertain and may arise from a 
claim which an enterprise pursues through a legal proceeding. There is uncertainty in realisation 
of claim. It is possible that recognition of contingent assets may result in recognition of income 
that may never be realised. However, when the realisation of income is virtually certain, then 
the related asset no longer remains as contingent asset. 
A contingent asset need not be disclosed in the financial statements. A contingent asset 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 enterprise), if 
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. 
 4.2  CONTINGENT LIABILITIES 
The term ‘Contingent liability’ can be defined as 
“(a)  a possible obligation that arises from past events and the existence of which will be 
confirmed only by the occurrence or non-occurrence of one or more uncertain future 
events not wholly within the control of the enterprise; or 
(b) a present obligation that arises from past events but is not recognised because: 
(i) it is not probable that an outflow of resources embodying economic benefits 
will be required to settle the obligation; or 
(ii) a reliable estimate of the amount of the obligation cannot be made.” 
For example- Mr. X sells a machine to Mr. Y. Any damages incurred by Mr. Y while using the 
machine need to be compensated by Mr. X. A few days later from the date of sale of machine, 
Mr. X received a notice from Mr. Y who is claiming damages of ` 20 lac. The notice mentioned 
that a worker met with an accident during the use of the machine and is required to be 
compensated. 
The receipt of this notice does not suggest that Mr. X is liable to pay the amount, although 
this needs to be investigated and confirmed, as whether the damage arose due to any defect 
in the machine or it is due to negligence while operating the machine. Although, the receipt 
of the notice results into an event which requires recognition of a contingent liability since 
there is a possible obligation, and that can only be confirmed in future. 
Taking another example let us assume Mr. AB sells cars to its customers. One of the cars 
caught fire due to malfunctioning of a faulty part during the test drive by one of the 
customers. The customer has filed a court case seeking a claim of ` 50 lac due to the incidence. 
© The Institute of Chartered Accountants of India
  ACCOUNTING 
1.76 
1.76 
While Mr. AB acknowledges that there is a present obligation, it is not certain that whether 
he is expected to pay for any damages. The final outcome will only be known during the court 
proceedings. 
A contingent liability is a possible obligation arising from past events and may arise in future 
depending on the occurrence or non-occurrence of one or more uncertain future events [part 
(a) of the definition]. A contingent liability may also be a present obligation that arises from 
past events [(part (b) of the definition)]. 
An enterprise should not recognise a contingent liability in balance sheet, however it is 
required to be disclosed in the notes to accounts, unless possibility of outflow of a 
resource embodying economic benefits is remote. These liabilities are assessed continually 
to determine whether an outflow of resources embodying economic benefits has become 
probable.  
If it becomes probable that an outflow or future economic benefits will be required for an 
item previously dealt with as a contingent liability, a provision is recognised in 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. 
 4.3 DISTINCTION BETWEEN CONTINGENT LIABILITIES 
AND LIABILITIES 
The distinction between a liability and a contingent liability is generally based on the 
judgement of the management. A liability is defined as the present financial obligation of an 
enterprise, which arises from past events. The settlement of a liability results in an outflow 
from the enterprises of resources embodying economic benefits. On the other hand, in the 
case of contingent liability, either outflow of resources to settle the obligation is not probable 
or the amount expected to be paid to settle the liability cannot be measured with sufficient 
reliability.  
Examples of contingent liabilities are claims against the enterprise not acknowledged as debts, 
guarantees given in respect of third parties, liability in respect of bills discounted and statutory 
liabilities under dispute etc. In addition to present obligations that are recognized as liabilities 
in the balance sheet, enterprises are required to disclose contingent liability in their balance 
sheets by way of notes. 
 
© The Institute of Chartered Accountants of India
Page 4


  ACCOUNTING 
1.74 
1.74 
LEARNING OUTCOMES 
UNIT – 4 CONTINGENT ASSETS AND CONTINGENT 
LIABILITES 
 
After studying this Unit, you will be able to:
 
? Understand the meaning of the terms ‘Contingent Assets’ and 
‘Contingent Liabilities’. 
? Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’ 
 
 
 
 
 
 
 
 
 
 
 4.1  CONTINGENT ASSET 
A contingent asset may be defined as a possible asset that arises from past events and whose 
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain 
future events not wholly within the control of the enterprise. It usually arises from unplanned 
or unexpected events that give rise   to the possibility of an inflow of economic benefits to 
the business entity. For example, a claim that an enterprise is pursuing through legal process, 
where the outcome is uncertain, is a contingent asset. 
•A possible asset arises from past events and their
existence will be confirmed only after occurrence
or non-occurrence of one or more uncertain
future events.
Contingent Asset
•A possible obligation arising from past events and 
may arise in future depending on the occurrence 
or non-occurrence of one or more uncertain 
future events.
Contingent Liability
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
1.75
THEORETICAL FRAMEWORK 
 
As per the concept of prudence as well as the present accounting standards, an enterprise 
should not recognise a contingent asset. These assets are uncertain and may arise from a 
claim which an enterprise pursues through a legal proceeding. There is uncertainty in realisation 
of claim. It is possible that recognition of contingent assets may result in recognition of income 
that may never be realised. However, when the realisation of income is virtually certain, then 
the related asset no longer remains as contingent asset. 
A contingent asset need not be disclosed in the financial statements. A contingent asset 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 enterprise), if 
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. 
 4.2  CONTINGENT LIABILITIES 
The term ‘Contingent liability’ can be defined as 
“(a)  a possible obligation that arises from past events and the existence of which will be 
confirmed only by the occurrence or non-occurrence of one or more uncertain future 
events not wholly within the control of the enterprise; or 
(b) a present obligation that arises from past events but is not recognised because: 
(i) it is not probable that an outflow of resources embodying economic benefits 
will be required to settle the obligation; or 
(ii) a reliable estimate of the amount of the obligation cannot be made.” 
For example- Mr. X sells a machine to Mr. Y. Any damages incurred by Mr. Y while using the 
machine need to be compensated by Mr. X. A few days later from the date of sale of machine, 
Mr. X received a notice from Mr. Y who is claiming damages of ` 20 lac. The notice mentioned 
that a worker met with an accident during the use of the machine and is required to be 
compensated. 
The receipt of this notice does not suggest that Mr. X is liable to pay the amount, although 
this needs to be investigated and confirmed, as whether the damage arose due to any defect 
in the machine or it is due to negligence while operating the machine. Although, the receipt 
of the notice results into an event which requires recognition of a contingent liability since 
there is a possible obligation, and that can only be confirmed in future. 
Taking another example let us assume Mr. AB sells cars to its customers. One of the cars 
caught fire due to malfunctioning of a faulty part during the test drive by one of the 
customers. The customer has filed a court case seeking a claim of ` 50 lac due to the incidence. 
© The Institute of Chartered Accountants of India
  ACCOUNTING 
1.76 
1.76 
While Mr. AB acknowledges that there is a present obligation, it is not certain that whether 
he is expected to pay for any damages. The final outcome will only be known during the court 
proceedings. 
A contingent liability is a possible obligation arising from past events and may arise in future 
depending on the occurrence or non-occurrence of one or more uncertain future events [part 
(a) of the definition]. A contingent liability may also be a present obligation that arises from 
past events [(part (b) of the definition)]. 
An enterprise should not recognise a contingent liability in balance sheet, however it is 
required to be disclosed in the notes to accounts, unless possibility of outflow of a 
resource embodying economic benefits is remote. These liabilities are assessed continually 
to determine whether an outflow of resources embodying economic benefits has become 
probable.  
If it becomes probable that an outflow or future economic benefits will be required for an 
item previously dealt with as a contingent liability, a provision is recognised in 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. 
 4.3 DISTINCTION BETWEEN CONTINGENT LIABILITIES 
AND LIABILITIES 
The distinction between a liability and a contingent liability is generally based on the 
judgement of the management. A liability is defined as the present financial obligation of an 
enterprise, which arises from past events. The settlement of a liability results in an outflow 
from the enterprises of resources embodying economic benefits. On the other hand, in the 
case of contingent liability, either outflow of resources to settle the obligation is not probable 
or the amount expected to be paid to settle the liability cannot be measured with sufficient 
reliability.  
Examples of contingent liabilities are claims against the enterprise not acknowledged as debts, 
guarantees given in respect of third parties, liability in respect of bills discounted and statutory 
liabilities under dispute etc. In addition to present obligations that are recognized as liabilities 
in the balance sheet, enterprises are required to disclose contingent liability in their balance 
sheets by way of notes. 
 
© The Institute of Chartered Accountants of India
1.77
THEORETICAL FRAMEWORK 
 
 4.4 DISTINCTION BETWEEN CONTINGENT LIABILITIES 
AND PROVISIONS 
Provision means “any amount written off or retained by way of providing for depreciation, 
renewal or diminution in the value of assets or retained by way of providing for any known 
liability of which the amount cannot be determined with substantial accuracy”. 
It is important to know the difference between provisions and contingent liabilities. The 
distinction between both of them can be explained as follows: 
 Provision Contingent liability 
(1) Provision is a present liability of 
uncertain amount, which can be 
measured reliably by using a substantial 
degree of estimation. 
A Contingent liability is a possible 
obligation that may or may not crystallise 
depending on the  occurrence or non-
occurrence of one or more uncertain 
future events. 
(2) A provision meets the recognition 
criteria. 
A contingent liability fails to meet the 
same. 
(3) Provision is recognised when (a) an 
enterprise has a present obligation 
arising from past events; an outflow of 
resources embodying economic 
benefits is probable, and (b) a reliable 
estimate can be made of the amount of 
the obligation. 
Contingent liability includes present 
obligations that do not meet the 
recognition criteria because either it is not 
probable that settlement of those 
obligations will require outflow of 
economic benefits, or the amount cannot 
be reliably estimated. 
(4) If the management estimates that it is 
probable that the settlement of an 
obligation will result in outflow of 
economic benefits, it recognises a 
provision in the balance sheet. 
If the management  estimates, that it is 
less likely that any economic benefit will 
outflow the firm to settle the obligation, it 
discloses the obligation as a contingent 
liability. 
Let us take an example to understand the distinction between provisions and contingent 
liabilities. The Central Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision 
in the Central Excise Act. The company goes on an appeal. If the management of the company 
estimates that it is probable that the company will have to pay the penalty, it recognises a 
provision for the liability. On the other hand, if the management anticipates that the judgement 
of the appellate authority will be in its favour and it is less likely that the company will have to 
pay the penalty, it will disclose the obligation as a contingent liability instead of recognising a 
provision for the same. 
© The Institute of Chartered Accountants of India
Page 5


  ACCOUNTING 
1.74 
1.74 
LEARNING OUTCOMES 
UNIT – 4 CONTINGENT ASSETS AND CONTINGENT 
LIABILITES 
 
After studying this Unit, you will be able to:
 
? Understand the meaning of the terms ‘Contingent Assets’ and 
‘Contingent Liabilities’. 
? Distinguish ‘Contingent Liabilities’ with ‘Liabilities’ and ‘Provisions’ 
 
 
 
 
 
 
 
 
 
 
 4.1  CONTINGENT ASSET 
A contingent asset may be defined as a possible asset that arises from past events and whose 
existence will be confirmed only after occurrence or non-occurrence of one or more uncertain 
future events not wholly within the control of the enterprise. It usually arises from unplanned 
or unexpected events that give rise   to the possibility of an inflow of economic benefits to 
the business entity. For example, a claim that an enterprise is pursuing through legal process, 
where the outcome is uncertain, is a contingent asset. 
•A possible asset arises from past events and their
existence will be confirmed only after occurrence
or non-occurrence of one or more uncertain
future events.
Contingent Asset
•A possible obligation arising from past events and 
may arise in future depending on the occurrence 
or non-occurrence of one or more uncertain 
future events.
Contingent Liability
UNIT OVERVIEW 
© The Institute of Chartered Accountants of India
1.75
THEORETICAL FRAMEWORK 
 
As per the concept of prudence as well as the present accounting standards, an enterprise 
should not recognise a contingent asset. These assets are uncertain and may arise from a 
claim which an enterprise pursues through a legal proceeding. There is uncertainty in realisation 
of claim. It is possible that recognition of contingent assets may result in recognition of income 
that may never be realised. However, when the realisation of income is virtually certain, then 
the related asset no longer remains as contingent asset. 
A contingent asset need not be disclosed in the financial statements. A contingent asset 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 enterprise), if 
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. 
 4.2  CONTINGENT LIABILITIES 
The term ‘Contingent liability’ can be defined as 
“(a)  a possible obligation that arises from past events and the existence of which will be 
confirmed only by the occurrence or non-occurrence of one or more uncertain future 
events not wholly within the control of the enterprise; or 
(b) a present obligation that arises from past events but is not recognised because: 
(i) it is not probable that an outflow of resources embodying economic benefits 
will be required to settle the obligation; or 
(ii) a reliable estimate of the amount of the obligation cannot be made.” 
For example- Mr. X sells a machine to Mr. Y. Any damages incurred by Mr. Y while using the 
machine need to be compensated by Mr. X. A few days later from the date of sale of machine, 
Mr. X received a notice from Mr. Y who is claiming damages of ` 20 lac. The notice mentioned 
that a worker met with an accident during the use of the machine and is required to be 
compensated. 
The receipt of this notice does not suggest that Mr. X is liable to pay the amount, although 
this needs to be investigated and confirmed, as whether the damage arose due to any defect 
in the machine or it is due to negligence while operating the machine. Although, the receipt 
of the notice results into an event which requires recognition of a contingent liability since 
there is a possible obligation, and that can only be confirmed in future. 
Taking another example let us assume Mr. AB sells cars to its customers. One of the cars 
caught fire due to malfunctioning of a faulty part during the test drive by one of the 
customers. The customer has filed a court case seeking a claim of ` 50 lac due to the incidence. 
© The Institute of Chartered Accountants of India
  ACCOUNTING 
1.76 
1.76 
While Mr. AB acknowledges that there is a present obligation, it is not certain that whether 
he is expected to pay for any damages. The final outcome will only be known during the court 
proceedings. 
A contingent liability is a possible obligation arising from past events and may arise in future 
depending on the occurrence or non-occurrence of one or more uncertain future events [part 
(a) of the definition]. A contingent liability may also be a present obligation that arises from 
past events [(part (b) of the definition)]. 
An enterprise should not recognise a contingent liability in balance sheet, however it is 
required to be disclosed in the notes to accounts, unless possibility of outflow of a 
resource embodying economic benefits is remote. These liabilities are assessed continually 
to determine whether an outflow of resources embodying economic benefits has become 
probable.  
If it becomes probable that an outflow or future economic benefits will be required for an 
item previously dealt with as a contingent liability, a provision is recognised in 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. 
 4.3 DISTINCTION BETWEEN CONTINGENT LIABILITIES 
AND LIABILITIES 
The distinction between a liability and a contingent liability is generally based on the 
judgement of the management. A liability is defined as the present financial obligation of an 
enterprise, which arises from past events. The settlement of a liability results in an outflow 
from the enterprises of resources embodying economic benefits. On the other hand, in the 
case of contingent liability, either outflow of resources to settle the obligation is not probable 
or the amount expected to be paid to settle the liability cannot be measured with sufficient 
reliability.  
Examples of contingent liabilities are claims against the enterprise not acknowledged as debts, 
guarantees given in respect of third parties, liability in respect of bills discounted and statutory 
liabilities under dispute etc. In addition to present obligations that are recognized as liabilities 
in the balance sheet, enterprises are required to disclose contingent liability in their balance 
sheets by way of notes. 
 
© The Institute of Chartered Accountants of India
1.77
THEORETICAL FRAMEWORK 
 
 4.4 DISTINCTION BETWEEN CONTINGENT LIABILITIES 
AND PROVISIONS 
Provision means “any amount written off or retained by way of providing for depreciation, 
renewal or diminution in the value of assets or retained by way of providing for any known 
liability of which the amount cannot be determined with substantial accuracy”. 
It is important to know the difference between provisions and contingent liabilities. The 
distinction between both of them can be explained as follows: 
 Provision Contingent liability 
(1) Provision is a present liability of 
uncertain amount, which can be 
measured reliably by using a substantial 
degree of estimation. 
A Contingent liability is a possible 
obligation that may or may not crystallise 
depending on the  occurrence or non-
occurrence of one or more uncertain 
future events. 
(2) A provision meets the recognition 
criteria. 
A contingent liability fails to meet the 
same. 
(3) Provision is recognised when (a) an 
enterprise has a present obligation 
arising from past events; an outflow of 
resources embodying economic 
benefits is probable, and (b) a reliable 
estimate can be made of the amount of 
the obligation. 
Contingent liability includes present 
obligations that do not meet the 
recognition criteria because either it is not 
probable that settlement of those 
obligations will require outflow of 
economic benefits, or the amount cannot 
be reliably estimated. 
(4) If the management estimates that it is 
probable that the settlement of an 
obligation will result in outflow of 
economic benefits, it recognises a 
provision in the balance sheet. 
If the management  estimates, that it is 
less likely that any economic benefit will 
outflow the firm to settle the obligation, it 
discloses the obligation as a contingent 
liability. 
Let us take an example to understand the distinction between provisions and contingent 
liabilities. The Central Excise Officer imposes a penalty on Alpha Ltd. for violation of a provision 
in the Central Excise Act. The company goes on an appeal. If the management of the company 
estimates that it is probable that the company will have to pay the penalty, it recognises a 
provision for the liability. On the other hand, if the management anticipates that the judgement 
of the appellate authority will be in its favour and it is less likely that the company will have to 
pay the penalty, it will disclose the obligation as a contingent liability instead of recognising a 
provision for the same. 
© The Institute of Chartered Accountants of India
  ACCOUNTING 
1.78 
1.78 
SUMMARY 
?  A contingent asset may be defined as a possible asset that arises from past events and 
whose existence will be confirmed only after occurrence or non-occurrence of one or 
more uncertain future events not wholly within the control of the enterprise. 
?  A contingent liability is a possible obligation arising from past events and may arise in 
future depending on the occurrence or non-occurrence of one or more uncertain 
future events. 
?  A liability is the present financial obligation of an enterprise, which arises from past 
events whereas contingent liability is a possible obligation arising from past events. 
?  Provision is a present liability of uncertain amount, which can be measured reliably by 
using a substantial degree of estimation whereas Contingent liability is a possible 
obligation that may or may not crystallise depending on the occurrence or non-
occurrence of one or more uncertain future events. 
TEST YOUR KNOWLEDGE 
True and False 
1. A contingent liability need not be disclosed in the financial statements. 
2. A Provision fails to meet the recognition criteria. 
3. A claim that an enterprise is pursuing through legal process, where the outcome is 
uncertain, is a contingent liability. 
4. When it is probable that the firm will need to pay off the obligation, this gives rise to 
Contingent liability. 
5. Present financial obligation of an enterprise, which arises from past event is termed as 
contingent liability. 
Multiple Choice Questions 
1. Contingent asset usually arises from unplanned or unexpected events that give rise to 
(a) The possibility of an inflow of economic benefits to the business entity. 
(b) The possibility of an outflow of economic benefits to the business entity. 
(c) Either (a) or (b). 
 
© The Institute of Chartered Accountants of India