3.3 Application of the Gain Contingency Model
ASC 450-30-25-1 indicates that a gain contingency should not be recognized “before its realization.” The realization of a gain occurs at the earlier of when the gain is realized or when it is realizable. This view is based on paragraph 83 of FASB Concepts Statement 5 (codified in ASC 450), which states, in
part:
Revenues and gains of an enterprise during a period
are generally measured by the exchange values of the assets (goods or services)
or liabilities involved, and recognition involves consideration of two factors,
(a) being realized or realizable and (b) being earned, with sometimes one and
sometimes the other being the more important consideration.
- Realized or realizable. Revenues and gains generally are not recognized until realized or realizable. Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Readily convertible assets have (i) interchangeable (fungible) units and (ii) quoted prices available in an active market that can rapidly absorb the quantity held by the entity without significantly affecting the price. [Footnote omitted]
An entity must often use significant judgment to determine when
realization of a gain has occurred. Substantially all uncertainties about the
realization of a gain should be resolved before the gain contingency is considered
realized or realizable and recognized in the financial statements. A gain is
realized when cash or a claim to cash has been received and the cash (or claim to
cash) is not subject to refund or clawback. A claim to cash supporting realization
of a gain may be in the form of a receivable. Such receivables may arise through (1)
legally binding contractual arrangements detailing payment terms or (2) evidence
provided by an insurer that all contingencies have been resolved and that the
insurer will pay the insured party’s claim with no right to repayment. It may be
appropriate to recognize a gain contingency when it is realizable, although we would
generally not expect this to be a common occurrence. A gain is realizable when
assets received or held are readily convertible to a known amount of cash (or claim
to cash).
An entity must thoroughly analyze all relevant facts and
circumstances related to the gain contingency to support a conclusion that (1) a
gain has been realized or (2) assets are readily convertible to cash in a known
amount and the gain is therefore realizable. For an entity to recognize a gain
contingency, the claim to cash must meet the definition of an asset in paragraphs
E16 and E17 of FASB Concepts Statement 8, Chapter 4. Paragraph E17 states, in
part:
An asset has the following two essential characteristics:
- It is a present right.
- The right is to an economic benefit.
Connecting the Dots
Upon a litigation settlement determined by the courts or
other authoritative bodies, an agreement often is executed that outlines the
payments to be made by one or both of the parties and the timing thereof. In
these situations, there is no longer a gain contingency because the
agreement represents a claim to cash and the gain therefore has been
realized. The executed agreement represents a contractual receivable since
no contingencies remain. The party with the right to receive cash proceeds
would assess the contractual receivable for impairment as described in
Section
2.2.3.
In concluding that a gain has been realized or is realizable, an
entity should consider the nonexhaustive list of factors in the illustration below.
Sections 3.4 through
3.6 expand upon the factors shown in the illustration.
Besides the factors identified above, the entity should consider
additional facts and circumstances, the nature of the agreement, and consultation
with accounting advisers, as further discussed below.