How To Account For Provisions, Contingent Assets And Contingent Liabilities
Accounting is one of the main activities in a business organization. It is not a process that can be carried out in an arbitrary fashion. There are many concepts, standards, rules and guidelines provided by many governing bodies both local and international to standardize and monitor that the financial statements prepared by the organizations provide a true and fair view. The International Financial Reporting Standards (IFRS), International Accounting Standards (IAS) and other standards that are prepared by the Chartered Accountants Association of a particular country sets the standards and practices for the accounting of the transactions and events. This article is about the application of one such standard which is accounting for Provisions, contingent assets and contingent liabilities.
A provision can be defined as any type of liability that is uncertain both in amount and timing. A company can make a provision or reserve a certain amount of their profit for any liability that can result in an outflow of cash from an entity. But such a liability will be regarded a provision only if it results from past transactions and events, there is a probable payment and if the amount can be reliably estimated. For example a provision can be made for those debtors who are more likely to default payment; named provision for doubtful debts. In most occasions expenses such as bad debts, products liability insurance, depreciation etc. can be mistaken for provisions. Yet most commonly made provisions are Provision for bad doubtful debts, provision for depreciation, and provision for warranty etc.
This is a possible outflow of cash or a possible liability that can happen based on the incidence or the absence of an occurrence of a future event. For example if a product produced by a company is found to be of some fault and it caused any damage to the consumer, and the consumer has filed a case against the company and it is more likely that the company will be held liable to pay compensation for the consumer, it can be regarded as a contingent liability. A possible claim on a warranty could also be considered a contingent liability. But a purchase of a products liability insurance or the payment of premium for such insurance will not be regarded as contingencies but as expenses. Contingent liabilities are not necessary recognized or recorded but they must be released in financial declarations in the form of a note, check this trusted inland transit insurance coverage.
Contingent assets are very similar to a contingent liabilities. It is a possible cash inflow that can arise due to the event of a future income. Similar to contingent liabilities, contingent assets are not recorded or recognized but are disclosed in the form of a note in the financial statements.