Once, a wealthy merchant named Ramesh owned a large fleet of ships. One day, one of his ships accidentally damaged a fishing boat while docking at a port. The fishermen demanded compensation of ₹10 lakhs for their loss. However, Ramesh didn’t know yet how much he actually has to pay—the court would decide that later. This created a lot of confusion in his accounting books.
In the kingdom of Accounting, there was a wise sage known as IND AS 37. His role was to bring fairness and clarity to uncertain situations, especially when businesses didn’t know how much they might owe or gain in the future. He taught everyone 3 important lessons—Provisions, Contingent Liabilities, and Contingent Assets.
Ramesh sought the guidance of IND AS 37 to understand how to deal with this situation.
Lesson 1: The Provision
The sage said, “If you are fairly certain that you will have to pay a significant amount, even if you don’t know the exact figure yet, you must set aside money in your books as a provision.”
Ramesh asked, “But how do I decide if I’m certain enough?”
IND AS 37 smiled and explained the 3 magical conditions for a provision:
1. A present obligation exists:
You are responsible for the damage caused by your ship.
2. It’s probable you’ll pay:
Since the fishermen have a valid claim, it’s likely the court will rule against you.
3. The amount can be estimated:
Even though the exact amount isn’t fixed, your legal team says ₹10 lakhs is a reasonable estimate.
IND AS 37 said, “you must record ₹10 lakhs as a provision in your accounts.”
Lesson 2: The Contingent Liability
Ramesh then asked, “What if I think the court will rule in my favour, but there’s still a small chance I might lose?”
IND AS 37 replied, “This is a contingent liability. It’s like a dark cloud—it might rain, or it might not. Since you don’t expect to pay, you don’t record it as a liability. But you must disclose it in the notes to your accounts so others know about the risk.”
Ramesh understood. “So, if the chances of losing are very low, I don’t need to set aside money, but I still need to tell my investors?”
“Exactly!” said IND AS 37.
Lesson 3: The Contingent Asset
Excited by the lessons, Ramesh asked, “What if I stand to gain money?
For example, what if another company owes me money, but I’m not sure when or if they’ll pay?”
The sage said, “It is called a contingent asset. However, you can’t recognize it in your books until the income is virtually certain. Overconfidence can lead to misleading accounts!”
For example, if Ramesh was suing another shipping company and expected to win ₹5 lakhs, he could only recognize the asset once the court ruled in his favour.
Ramesh followed these principles, and soon all businesses in the kingdom did the same. Whenever uncertainties arose:
- Provisions were created for probable obligations.
- Contingent liabilities were disclosed, not recorded.
- Contingent assets were recognized only when certain.
This brought transparency and trust to financial reporting. Investors and stakeholders could now understand a company’s risks and potential rewards better than ever.
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