ACCA Advanced Audit and Assurance (AAA) Practice Exam

What is the result when a contingent liability is deemed not probable?

1. The obligation is recorded on the balance sheet

2. The obligation is disregarded in financial statements

3. The obligation is disclosed in the notes

4. The obligation is classified as a legal liability

The correct answer is: The obligation is disregarded in financial statements

When a contingent liability is deemed not probable, the appropriate treatment is to disregard the obligation in the financial statements. This is based on the accounting principle surrounding contingent liabilities, particularly as per accounting standards such as IAS 37, which states that only those obligations that are probable and can be reliably measured should be recognized in the financial statements. In cases where the likelihood of the outflow of resources embodying economic benefits is low, the obligation is not recognized in the balance sheet. It does not meet the criteria for recognition as a liability since the potential future liability is not seen as likely to occur. Therefore, it will not have a direct impact on the balance sheet or income statement. This approach ensures that financial statements present a true and fair view of the financial position, without including liabilities that are uncertain. While there may be situations where a contingent liability, even if not probable, could be disclosed in the notes if deemed relevant, the key reason for it being disregarded rather than recorded or recognized as a legal liability is to avoid overstating the liabilities of the entity. Thus, regarding it as an obligation that is simply disregarded aligns with both prudence and relevance in financial reporting.