A company has filed an insurance claim following a warehouse fire. At year end, in-house legal counsel assesses that recovery from the insurer is probable but not virtually certain. Under IAS 37, how should the company account for the potential insurance recovery at year end?
- Recognise the expected recovery as an asset and as income in profit or loss, since a probable inflow is enough to recognise a contingent asset
- Recognise the expected recovery as an asset, but only as a reduction of the related loss rather than as separate income
- Ignore the potential recovery entirely, since contingent assets are never referred to anywhere in the financial statements until cash is actually received
- Disclose the contingent asset and a brief description of its nature in the notes, without recognising any asset or income, because realisation is probable but not yet virtually certain
Why D? And why not the others?
Correct answer: D. Disclose the contingent asset and a brief description of its nature in the notes, without recognising any asset or income, because realisation is probable but not yet virtually certain
IAS 37 sets a higher recognition threshold for contingent assets than for provisions: a contingent asset is only recognised once realisation of the inflow is virtually certain, at which point it is no longer treated as contingent at all. Where an inflow is merely probable — as here, where counsel assesses recovery as probable but not virtually certain — the standard requires disclosure of the contingent asset and a brief description of its nature, without recognising any asset or income. Both options that recognise an asset or income at year end — whether as separate income or as an offset against the loss — apply the virtually-certain threshold too loosely, treating 'probable' as if it were sufficient, when IAS 37 deliberately sets a stricter bar for assets than the 'probable' threshold used for recognising provisions. The option ignoring the recovery entirely overcorrects in the other direction: a probable inflow that falls short of virtually certain still triggers a disclosure obligation under IAS 37, so complete silence about the claim is not the correct treatment either.
Source: IAS 37 Provisions, Contingent Liabilities and Contingent Assets, paragraphs 31–35 (contingent assets: recognition and disclosure)