A factory owned by CCT Limited was destroyed by fire. CCT Limited lodged an insurance claim for the value of the factory building, plant, and an amount equal to one year’s net profit. During the year there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that CCT Limited would receive compensation for 90% of its claim. CCT Limited received a letter that the settlement check for that amount had been mailed,but it was not received before year-end. How should CCT Limited treat this in its financial statements?a.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received.b.Wait until next year when the settlement check is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset.c.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.d.Disclose the contingent asset in the footnotes.
Question
A factory owned by CCT Limited was destroyed by fire. CCT Limited lodged an insurance claim for the value of the factory building, plant, and an amount equal to one year’s net profit. During the year there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that CCT Limited would receive compensation for 90% of its claim. CCT Limited received a letter that the settlement check for that amount had been mailed,but it was not received before year-end. How should CCT Limited treat this in its financial statements?a.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received.b.Wait until next year when the settlement check is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset.c.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.d.Disclose the contingent asset in the footnotes.
Solution
The correct treatment in CCT Limited's financial statements would be option c. Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, CCT Limited should record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.
Here's the step-by-step reasoning:
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A contingent asset is a potential asset that may arise 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. In this case, the contingent asset is the insurance claim lodged by CCT Limited for the fire damage.
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According to the International Accounting Standards (IAS 37), a contingent asset should not be recognized in financial statements until realization is virtually certain. If an inflow of economic benefits is only probable, not virtually certain, then no asset is recognized, but a disclosure is made in the financial statements.
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In this case, the insurance company has confirmed the settlement and stated that the check for 90% of the claim is in the mail. This makes the realization of the asset (the insurance claim) virtually certain, and therefore, it should be recognized in the financial statements.
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However, only 90% of the claim is virtually certain to be realized, not the full 100%. Therefore, CCT Limited should only recognize 90% of the claim as a receivable in its financial statements. The remaining 10% is still uncertain and should not be recognized at this point.
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