Accounting Treatment of Contingent Assets and Contingent Liabilities in case of Dissolution of a firm

Contingent Assets:

A Contingent Asset is an economic gain that may come into existence in near future as a result of some past action. The existence of such assets is completely uncertain and beyond the control of the entity.

Example: Any property of a firm under some legal suit, and warranty received by a firm.

Contingent Liabilities:

A Contingent Liability is a liability, the existence of which depends upon the happening of some future events. Like Contingent Assets, Contingent Liabilities are uncertain and beyond the control of the entity.

Example: Any compensation likely to be paid in near future as a result of some lawsuit, warranty given by the firm, discounting, or endorsement of bills.

Accounting Treatment of Contingent Assets:

(i) Contingent Assets realised for Cash:

A Contingent Asset, if any, like any other asset is transferred to the credit side of a Realisation Account on being realised for cash.

Journal Entry:

(ii) If any of the partners take over Contingent Assets and agrees to pay for the same:

A Contingent Asset when taken over by a partner, is transferred to the credit side of a Realisation Account and debited to Concerned Partner’s Capital Account.

Journal Entry:

Accounting Treatment of Contingent Liabilities:

(i) Contingent Liabilities paid off:

Like any other liability, the Contingent Liability is also paid off and is transferred to the debit side of a Realisation Account.

Journal Entry: 

(ii) If any of the partners agrees to settle a Contingent Liability:

A Contingent Liability when taken over by a partner, is transferred to the debit side of a Realisation Account and credited to Concerned Partner’s Capital Account.

Journal Entry:

Illustration:

Raman, Sita and Anand were partners sharing Profit in the ratio of 2 : 2 : 1. Their Balance Sheet on 31st March 2020 stood as:

Additional Information:

1. Assets realised as:

Stock – ₹ 67,200

Debtors – 90% of value

Machinery – ₹ 1,32,000

2. Sita took over the Investment at ₹ 28,800 and also agrees to pay the outstanding salary.

3. Patents were valueless.

4. A Bill Receivable of ₹ 7,200 was discounted from a bank, but on the due date, the Customer become insolvent and paid only 70 paise in a rupee. 

5. Creditors realised for ₹ 64,800.

6. Realisation expenses amounted to ₹ 2,880.

Prepare Realisation Account, Partner’s Loan Account, Partner’s Capital Account and Cash Account and pass necessary Journal Entries.

Solution:

Working Notes:

1. Total Realised Value of Assets:

Stock = 67,200

Debtors = 62,640

Machinery = 1,32,000

Bill Receivable (Contingent Asset)  = 5,040 

Total = 2,66,880 

2. Total Liabilities Realised:

Creditors  = 64,800

Bill Receivable
(Contingent Liability) = 7,200

Short-term Loan = 48,000

Total = 1,20,000

Note: Full value of the Bill Receivable is considered as Contingent Liability because the full amount is to be returned to the Bank. However, 70% of it is received hence that part is considered as Contingent Asset.