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Topic 4 - Provisions, Contingent Liabilities and Contingent Assets

This document discusses provisions, contingent liabilities, and contingent assets under PAS 37. It defines provisions as liabilities of uncertain timing or amount that arise from past events like warranties or lawsuits. Provisions are recognized if an outflow is probable and can be reliably estimated. Contingent liabilities and assets may or may not arise depending on uncertain future events, so they are only disclosed. Provisions are measured at management's best estimate of the expenditure required to settle the obligation, considering factors like risk and the time value of money. The document provides examples of common types of provisions like warranties, premiums, and decommissioning liabilities.

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12 views

Topic 4 - Provisions, Contingent Liabilities and Contingent Assets

This document discusses provisions, contingent liabilities, and contingent assets under PAS 37. It defines provisions as liabilities of uncertain timing or amount that arise from past events like warranties or lawsuits. Provisions are recognized if an outflow is probable and can be reliably estimated. Contingent liabilities and assets may or may not arise depending on uncertain future events, so they are only disclosed. Provisions are measured at management's best estimate of the expenditure required to settle the obligation, considering factors like risk and the time value of money. The document provides examples of common types of provisions like warranties, premiums, and decommissioning liabilities.

Uploaded by

DustinEarth Buyo Montebon
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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TOPIC 4 – PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

Related standards:
PAS 37 Provisions, Contingent Liabilities and Contingent Assets

Learning Objectives:
1. State the recognition criteria for provisions.
Provision  is “a liability of uncertain timing or amount”. Examples include:
a. Warranty obligations
b. Estimated liabilities on pending lawsuits
c. Provisions for environmental damages
d. Provisions of decommissioning costs of an item of PPE
e. Obligations caused by an entity’s policy to make refunds to customers
f. Obligations arising from guarantees
g. Provisions on onerous contracts (e.g., purchase commitment)
h. Provisions for restructuring costs

Recognition: A provision is recognized when all of the following conditions are met:
 Present obligation resulting from past event;
 Probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
 Amount can be reliably estimated.

2. Differentiate the accounting requirements of a provision, a contingent liability and a contingent asset.
Contingent  refer to those liabilities and assets that are not recognized because they do not meet all of the
recognition criteria. They are only disclosed except when the possibility of an outflow of resources embodying
economic benefits is remote (in which case the item is ignored and not accounted for).

Provision Contingent Liability


Chance of happening of an event
Contingent
Probable Possible Remote
Liability Recognize and disclose Disclose only Ignore
Asset Disclose only Ignore Ignore

3. Describe the available measurement bases for a provision.


 Provisions are measured at the best estimate (including risk and uncertainties) of the expenditure required to
settle the present obligation, and reflects the present value of expenditures required to settle the obligation
where the time value of money is material.
 In measuring a provision consider future events as follows:
 forecast reasonable changes in applying existing technology
 ignore possible gains on sale of assets
 consider changes in legislation only if virtually certain to be enacted

Nature of the outflow Measurement basis


1. General rule Best estimate
2. Involves a large population of items Expected value (Probability Weighted Average)
3. Each possible outcome in a range is as likely as any other Mid-point

4. Account for provisions.


Adjusting entry:
Expense (or loss) – debit
Estimated liability account – credit

Remeasurement of provisions:
 Review and adjust provisions at each balance sheet date
 If an outflow no longer probable, provision is reversed
Other measurement considerations:
a. Risk and uncertainties – a risk adjustment factor is considered in computing the provision
b. Present value of obligation – consider if the time value of money is material
c. Future events – consider only if there is sufficient evidence that it will occur
d. Expected disposal of assets – not considered
e. Reimbursements – consider only if virtually certain. it should not be netted against the estimated liability
f. Changes in provision – should be reviewed at every year-end
g. Future operating loss – not considered
h. Onerous contracts – lower amount between the cost of fulfilling the contract and the compensation or penalty arising
from failure to fulfill the contract

Restructuring
 A program that is planned and controlled by management, and materially changes either:
a. The scope of a business undertaken by an entity; or
b. The manner in which that business is conducted.

Examples:
 Sale or termination of a line of business
 Closure of business locations
 Changes in management structure
 Fundamental reorganizations

Restructuring provisions should be recognized as follows:


 Sale of operation: recognize a provision only after a binding sale agreement.
 Closure or reorganization: recognize a provision only after a detailed formal plan is adopted and has started being
implemented, or announced to those affected. A board decision of itself is insufficient.
 Future operating losses: provisions are not recognized for future operating losses, even in a restructuring.
 Restructuring provision on acquisition: recognize a provision only if there is an obligation at acquisition date.

 Restructuring provisions should include only direct expenditures necessarily entailed by the restructuring, not costs
that associated with the ongoing activities of the entity.

PAS 37 specifically excludes the following expenditures from restructuring provision:


a. Cost of retraining or relocating continuing staff
b. Marketing and advertising program to promote the new company image
c. Investment in new system and distribution network

Decommissioning liability (asset retirement obligation)


- is an obligation to dismantle, remove and restore an item of property, plant and equipment as required by law or
contract.
- Such estimated liability will be settled in the future; hence it is normally measured at present value of the estimated
future cash outflows discounted at effective interest rate.
- Under IFRIC 1, changes in the measurement of existing decommissioning liability shall be accounted as addition or
deduction from the related cost of the asset.
Entries:
If there is an increase in the measurement of existing decommissioning liability:
Asset xxx
Estimated liability xxx

If there is an decrease in the measurement of existing decommissioning liability:


Estimated liability xxx
Asset xxx

Others common types of provisions


A. Product warranties and guarantees – e.g., sale of goods or services
PAS 37 PFRS 15
If the customer does not have the option to purchase If the customer has the option to purchase the
the warranty separately. warranty separately.
Accounting for warranty liability:
a. To record the sale
Cash or A/R xxx
Sales xxx

b. To set up estimated warranty liability:


Warranty expense xxx
Estimated warranty liability xxx
c. To record the payment of the actual cost of warranty:
Estimated warranty liability xxx
Cash xxx

Estimated Warranty Liability


Actual cost Beginning balance xxx
Accrual of expense xxx
Ending balance xxx
B. Premiums
 Refers to goods, services, cash prizes, or special rebates which are included in the main product or service being
offered. The purpose is to promote and increase sales.

Accounting for Premium Liability:


1. When the premiums are purchased:
Premium inventory xxx
Cash xxx
2. When premiums are distributed to customers:
Premium expense xxx
Premium inventory xxx

3. At the end of the year, if premiums are still outstanding:


Premium expense xxx
Estimated premium liability xxx
{no. of premiums expected to be distributed x net cost (cost less reimbursement from customers)}

Estimated Premium Liability


Actual cost Beginning balance xxx
Accrual of expense xxx
Ending balance xxx

Premium Inventory
Beginning balance xxx Redemption xxx
Purchase xxx
Ending balance xxx

PAS 37 PFRS 15
A customer option that does not provide the customer A customer option to acquire additional goods or
with a material right is accounted for under PAS 37. services for free or at a discount is accounted for
under PFRS 15 if the option provides the customer a
material right that the customer would not receive
without entering into that contract. Accordingly, the
entity has two performance obligations in these
customer options, namely:
a. To deliver or transfer the goods or products sold.
b. To satisfy the customer options for coupons for
free product, discount and rebate.

Under PFRS 15, paragraph 74, an entity is required to


allocate the transaction price of goods sold between
the products sold and the customer options based on
relative stand-alone selling price. The allocated
transaction price of the customer options shall be
deferred and recognized as income when options are
exercised or when options expire.

C. Guarantee of indebtedness of others becoming probable (e.g., as a co-maker of a loan).

--- END OF LECTURE NOTES ---

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