Most of us are comfortable throwing around the word “asset,” but what happens when we slap “contingent” in front of it? According to Merriam-Webster, something is contingent when it is “likely but not certain to happen: possible.” You might be thinking that definition can’t apply to an asset, but in fact it does, and quite literally.
Following is a succinct guide to contingent assets, from definitions to common examples to reporting contingent assets on the balance sheet. Streamline your understanding of assets with this lean finance course for startups.
What Are Contingent Assets?
For assets to be contingent, they must meet two simple qualifications:
- The asset – which, technically, is not yet a real asset – must have the potential to become one (in fact, it is not incorrect to refer to contingent assets as potential assets).
- The means by which the asset becomes real are beyond the company’s control.
This probably sounds like a case of dumb luck; how can an asset just fall into a company’s hands when it is beyond the company’s influence? The key to understanding contingent assets is not to think of them as physical entities; not cash, not office buildings, not inventory, etc. All of these assets have, or can have, definite values. But contingent assets are either of an unknown value or a yet-to-be-defined value.
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Contingent assets actually result from a company’s past actions (this will become crystal clear in the next section), so in this way they are not completely beyond the influence of the company, but they are almost never acquired intentionally or through forethought. The asset is contingent because its value is waiting to be determined by events in the future.
Litigation . . . Of Course!
That’s right: litigation is the number one producer of contingent assets; now that you know, it must seem terribly obvious. So assets with unknown fates are the result of pending litigation.
Let’s look at an example; preferably, something well-known that actually happened. How about Apple v. Samsung? As most of you will recall, Apple sued Samsung for using the same kind of rounded corners on its smartphones. It was a nit-picky and, in the end, a practically pointless lawsuit, but it was worth about $1 billion in contingent assets.
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Now, during the lawsuit, neither side knew what was going to happen. Apple certainly expected a contingent asset, but they could not accurately say how much it would be. $1 billion? $10 billion? $100 billion? Probably not the latter, but still: the lawsuit was filled with potential. In the end, Samsung was forced to pay Apple around $1 billion in damages; as soon as the ruling as announced, the contingent asset became, simply, an asset.
The Ole Balance Sheet
While contingent assets are still vague and impossible to determine, they are not reported. It doesn’t matter if it’s worth $100 billion; it may or may not happen and therefore cannot be reported accurately. If you want to know the ins and outs of balance sheets, check out this blog post that explains the components of balance sheets and why they’re important.
Large companies tread carefully around contingent assets, monitoring them almost constantly so that they can report them appropriately. Still, from the very beginning, contingent assets should show up in a company’s financial notes, and any and all updates should be recorded accordingly.
Lest we forget, there are two sides to every lawsuit. When it became obvious that Apple was going to receive $1 billion dollars, both companies would have made necessary adjustments. Apple would have immediately recorded this asset; indeed, they would have been required to. Even if the lawsuit had not yet been decided but they reached a point where an accurate estimate could be made, they would be required to record that, as well.
Conversely, Samsung would have to record a loss as soon as possible, too. This will be recorded as a loss contingency in the notes until it is made official.
When recording contingent assets in financial notes, all angles must be considered. All reasonable possibilities must be notes, all risks, all values and, in short, all aspects of the situation. For more information than you could ever want on balance sheets, check out this five-star course on interpreting financial statements.