04 May 2020
Given the degree of uncertainty surrounding the impact of coronavirus, entities will need to be mindful of potential obligations or assets that have never been considered as part of the normal reporting cycle but now require disclosure in the accounts, even though they are not recognised on the balance sheet.
What does FRS 102 say?
FRS 102 (section 21.12A) states that a contingent liability is either:
- a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or
- a present obligation that arises from past events but is not recognised because:
- it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
- the amount of the obligation cannot be measured with sufficient reliability.
If the possibility of an outflow of resources is remote, then no disclosure is required.
FRS 102 states that a contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
Practical impact and interpretation for preparers
Initially it will be necessary to determine whether the obligation should be recognised in the accounts as a provision, a contingent liability or requires no mention.
|Event occurs before the reporting date, future settlement outflow probable (ie >50%)||Yes||No|
|Event occurs before the reporting date, future settlement outflow possible (ie <50%)||No||Yes (disclose unless likelihood of outflow is ‘remote’)|
|Event occurs before the reporting date; future settlement outflow depends on future uncertain event||No||Yes (disclose unless likelihood of outflow is ‘remote’)|
|Event occurs before the reporting date; future settlement outflow cannot be estimated reliably||No||Yes (but expected to be rare)|
|Event occurs after the reporting date||No||No (but may be disclosable as a non-adjusting post-balance sheet event)|
- One of the key considerations is the entity’s reporting date and reference to “past event”, which is critical when considering both a possible obligation and a present obligation. Past events need to be before the reporting date for any contingent liability to be disclosed and therefore defining the past event is important. Whilst coronavirus might be the underlying event, it is only subsequent future events that are outside of the control of the entity that determines if a contingent liability is disclosable. For example, if the entity couldn’t fulfil orders before the reporting date due to coronavirus but customers only made a legal claim in this regard after the reporting date, if there is a possible future outflow, then a contingent liability disclosure would be needed.
- If the event is determined to occur before the reporting date, then unless the future outflow is probable ie more than 50per cent (in which case it will be recognised as a provision), a contingent liability disclosure is likely to be required.
Disclosures should detail an estimate of the financial effect; an indication of uncertainties to the amount or timing; and the possibility of any reimbursement. If it is impracticable to detail any of these that should be stated. Contingent liability disclosure is often a sensitive area given disclosure may (if option b is applicable) be interpreted by users that the entity accepts there is a present obligation as a result of a past event. However, whilst entities may challenge disclosure on seriously prejudicial grounds, the standard still requires some disclosure (FRS 102 section 21.17).
Entities may have in place, or have been required to recently put in place financial guarantee contracts, such as intercompany cross guarantees or arrangements, giving rise to joint and several liability including some where the likelihood of being called upon would normally be remote or have otherwise been overlooked (eg all members of a VAT group are jointly and severally liable to HMRC). Entities should reassess these financial guarantee contracts; the possible or present obligations; and the disclosures required under FRS 102 (sections 21.17A, 21.14 and 21.15).
As a result of various forms of financial assistance and the potential for insurance recoveries, consideration of contingent assets is an area that many entities will need to actively consider. Like contingent liabilities, the key will be determining where the past event falls with reference to the reporting date. For example, an insurance claim may relate to the event of coronavirus but may only be triggered by certain other events that happen after the reporting period eg loss of future bookings or margins falling below a specific level. These events after the reporting period would not trigger a contingent asset disclosure.
Where it’s shown that the potential asset arises as a result of a past event, and the inflow of economic benefits arising from that event is probable, disclosure of a contingent asset will be required describing the nature of the contingent asset and an estimate of the financial effect.
If an economic inflow is virtually certain then the related asset is no longer a contingent asset, and it should be recognised on the balance sheet as an asset.
- Carefully consider whether the specific event or action occurs before or after the reporting date.
- Consider the likelihood of any financial guarantee contracts being called in, and hence what disclosure is required, eg contingent liability.
- As more government guidance is released, and as business operations return to normal, entities should continually assess if there are potential liabilities that are possible but not probable. These may arise from changes to terms with suppliers or employees.
- Revisit accounts disclosures to ensure they contain the most up to date information relevant to the circumstances.