Accounting Standard 4 (AS 4) pertains to the treatment of the following items in the financial statements:
- Events occurring after the balance sheet date
Further, there are certain subjects which can lead to contingencies. However, these issues are outside the scope of this accounting standard on account of special considerations that apply to them. These include:
- Liabilities of Life Assurance and General Insurance enterprises resulting from policies issued
- Obligations under Retirement Benefit Plans
- Commitments arising from long term lease contracts
What is a Contingency?
The term contingency is defined as a state or a circumstance as on the balance sheet date the financial implications of which are known by the occurrence or the non-occurrence of any uncertain future events.
Furthermore, the financial implications of these future uncertain events could be favorable or unfavorable for the enterprise.
Therefore, it is important for the enterprise to differentiate between certain and uncertain events for an estimate to be called as a contingency. This is because the enterprise also generally provides estimates in respect of various on-going and recurring activities.
Thus, simply giving an estimate does not mean that the particular activity for which the estimate is being given is a contingency.
For example, a chartered accountant has been providing accounting and auditing services to your firm for which you are indebted to pay. Such an activity cannot be categorized as a contingency since there is nothing uncertain about the event.
Also, uncertainty regarding the future events can be indicated by a pool of outcomes. Such outcomes must be described generally in the financial statements if they cannot be reasonably quantified.
However, the enterprise must quantify such outcomes where is is possible to reasonably quantify them.
Finally, the estimates as well as the financial implications of these outcomes are established by the judgment of the management of the enterprise.
And, the management makes such a judgement by taking into account:
- information available up to the date on which such financial statements are approved
- an evaluation of events occurring after the balance sheet date
- experience of similar transactions and
- reports from independent experts
Accounting Treatment of Contingent Losses
Show a Contingent Loss
The anticipated result of a contingency governs the accounting treatment of the contingent loss. In other words, it is wise that you provide for a contingent loss in the financial statements if it is expected that a contingency would lead to a loss for the enterprise .
Estimate The Contingent Loss
The estimated amount of the contingent loss to be specified in the financial statements is based on your management’s judgment.
Cases Where Sufficient Evidence Is Not Available
There are situations when sufficient evidence is not available to provide an estimate of the amount of contingent loss. In such cases, you just need to give a simple disclosure of the nature and existence of such a contingency.
Cases Where There is a Counterclaim
There can be circumstances where a possible loss to your enterprise can be reduced or avoided. This is possible where a contingent liability has a complementing counterclaim or a claim against a third party.
Thus in these situations, the amount of provision is established after considering the possible recovery under the claim. Provided there exists no uncertainty in respect of its measurability or collectibility.
Provision for Guarantees or Obligations Arising from Bills of Exchange
You need to provide information regarding the amount of guarantees or obligations arising from discounted bills of exchange assumed by your enterprise in the financial statements. Such information needs to be given in the form of a note. This is regardless of the fact that the chances of loss occurring to your enterprise are low.
Provisions Regarding General Risks
There is no need to create provisions for contingencies regarding general and unspecified business risks. This is because such risks do not relate to the conditions existing at the time of the balance sheet date.
Accounting Treatment of Contingent Gains
When it comes to contingent gains, they are not shown in the financial statements. This is because showing contingent gains in financial statements would lead to recognizing financial revenue which may never materialize.
But when you are certain that such a gain would be materialized, it no more remains a contingency. And it is proper for you as a business to account for such a gain in the financial statements.
Determination of Contingency Amounts To Be Included In The Financial Statements
Amount of Contingency To Be Shown in Financial Statements
The amount of contingent loss to be specified in the financial statements must be based on the details available up to the date on which such financial statements are approved.
In addition to this, events taking place after the balance sheet date must be taken into account to declare contingencies and their relevant amounts in the financial statements. Such events are the ones that suggest that there existed an asset that has been impaired or a liability on the balance sheet date.
Identification of Contingency
There can be cases where each contingency can be recognized separately. Thus, you must consider special conditions for each such contingency to determine the amount at which such contingency must be declared.
Amount of Contingency Having Similar Characteristics
There can be circumstances where uncertainties resulting in a contingency pertaining to a particular transaction also result in contingencies with respect to other similar transactions.
In such situations, you can determine the amount of contingency based on a batch of these similar transactions in place of determining them individually.
Events Occurring After The Balance Sheet Date
Definition of Events Occurring After The Balance Sheet Date
Events Occurring After The Date of Balance Sheet refer to the ones that:
- take place between the date of balance sheet and the date on which such financial statements are approved and
- such events suggest a requirement to adjust assets and liabilities on the balance sheet date or may need a disclosure.
When To Adjust Assets and Liabilities in the Balance Sheet?
You need to adjust the assets and liabilities for events that take place after the balance sheet date. This needs to be done in cases where such events give additional information. Provided such information significantly affects the ascertainment of amounts relating to conditions existing at the date of balance sheet.
When Adjusting Assets and Liabilities in the Balance Sheet is not Appropriate?
There are cases where you need not adjust the assets and liabilities for events taking place after the balance sheet date. Such events are the ones that are not related to the conditions that exist on the balance sheet date.
Adjustment of Events Occurring After The Balance Sheet Date But Not Having Material Impact
There can be events that take place after the balance sheet date but do not have any impact on the amounts specified in the financial statements. Such events generally are not required to be disclosed in the financial statements. However, they may be of material nature to an extent that they need to be disclosed in the report of the approving authority. This is to help users of the financial statements to make appropriate evaluations and decisions.
Adjustment of Events Occurring After the Balance Sheet Date But To Be Shown Mandatorily
There can be events that occur after the balance sheet date. But you need to mandatorily declare such events in the financial statements either because of a statutory requirement or their special nature. For example, dividend Proposed or declared by the entity after the balance sheet date for the time period for which the financial statements are prepared.
Adjustment of Events Occurring After the Balance Sheet Date Suggesting That Business Entity is No Longer a Going Concern
There can be events occurring after the balance sheet date but which suggest that a business entity is no longer a going concern. Such events could include the declining operating results and financial position or some unusual changes that impact the existence or the very foundation of enterprise after the balance sheet date.
These events suggest that the enterprise needs to think over the fact whether it is appropriate to use the fundamental assumption of going concern while preparing its financial statements.
- The requirements for disclosure mentioned in the accounting standard 4 are applicable only to those contingencies or events which significantly impact the financial position of an enterprise.
- If the enterprise does not provide for a contingent loss, the nature and the estimate of the financial impact of such a loss is declared in the financial statements in the form of a note. Provided the probability of such a loss is not remote. Further, if the enterprise cannot make a reliable estimate of the financial impact of such a loss, such a fact should be disclosed in the financial statements.
- There are events that take place after the balance sheet date and are declared in the report of the approving authority. The information regarding such events include their nature, an estimate of their financial impact or a statement specifying that such an estimate cannot be made.