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Why Contingent Assets Are Not on Balance Sheets

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Why Contingent assets are not on balance sheets.

It is a key principle for accountants to give a fair and true view of a business to help people that use this information to make more informed decisions. It is important to provide the users, accurate financial information that is as close to the true circumstances as possible and so not to alter the decisions of the users. Accountants produce financial statements that display all of the useful information for all user groups. One of the most common financial statements is the balance sheet. The purpose of the balance sheet is to show the financial position of an entity at a certain point in time by presenting assets, liabilities and ownership interest. The balance sheet reflects the accounting equation (assets minus liabilities equals ownership interest). An asset can be defined as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity” (Weetman, 2006).

Not all of the company assets and liabilities always appear on the balance sheet for different reasons, even though they meet the definition of an asset. These assets are called off-balance-sheet assets (OBS). The OBS is not part of the balance sheet and it acts as a note of disclosure. The OBS has featured in the headlines of many news articles. This is because businesses have been using OBS financing to keep their leverage and debt to equity ratios low. The term OBS financing became popular during the well-known Enron bankruptcy. Enron were setting up inappropriate OBS entities and so their accountants were portraying a false view of their balance sheet.

Although an item may be defined as an asset it may not actually be recognised in the balance sheet as an asset because it does not meet the tests of recognition. An asset is recognised when “it is probable that the future…...

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