IAS37

Question 1

Define provision

Answer 1

Provision is a liability of uncertain timings or amount.

Question 2

What were the problems when there was no accounting standard for provisions?

Answer 2

there was no proper definiton, recognition, measurement.
ppl just made a provision to understate profit and overstate liabilities.

1) people made provisions when they intended to make an expense rather than when they were 100% sure. and then they reversed them to get artificial income

2) inadequate disclosures.

3) management would make RAINY DAY
(make provision in times of good profit and reverse it later in bad times to “smooth profits” or BIG BATH provisions (making this year worse so next year profit looks better)

4) diff ppl recognised provision differently, ad that reduced comparability of FS and effected EPS as a stock market indictor.

mining company eg:
they ignored the costs to make site good again after closure of mines, until the cost actually occurred. they said it was consistent with accrual concept. THey used a loophole instead of a main hole.

Question 3

What are the conditions for recognising a provision?

Answer 3

1. present obligation (legal or constructive) to transfer economic resources due to past event.
2. probable outflow
3. reliable estimate of the obligation can be made.

if conditions arent met provision should not be recognised.

Question 4

What are the two types of present obligations?

Answer 4

legal obligation: an obligation that exists by law, eg. a contract, legislation etc.

constructive obligation: is not required by law but it may exist due to:
-past practice pattern, policies, statements, etc

Question 5

What are the two types of statistical tools?

Answer 5

1- most likely outcome (for a single obligation. other possible outcomes shud also be considered and reflected when reflecting provision.
2- Expected value analysis (used in situations where there is a large population)

Question 6

define contingent liability:

Answer 6

contingent liability: no entry only disclosure

possible obligation that arises from past events but will be confirm only on occurrence of 1 or more future events which are not wholly within the entity’s control.
OR
present obligation that arises from past events but is not recognised because:
-an outflow of resources is not probable
-amount of obligation can not be measured with sufficient reliability ( very rare)

Question 7

define contingent asset

Answer 7

a possible asset which arises from past events and whose existence will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events not wholly within the entity’s control.

Question 8

define onerous contract.
give an example.
what is the accounting treatment?

Answer 8

a contract is signed

unavoidable costs of meeting the obligations > the economic benefits
eg. a loss-making contract with a customer.
treatment:
recognized as a provision because obligation is there

amount of provision:
lower of
1) PV of future rentals
2) penalty

Question 9

what are restructuring costs. give examples of restructuring

Answer 9

a program which is planned and controlled by management
and materially changes
1) scope of business undertaken by an entity
2) the manner in which business is conducted.

examples are:
-closing a line of business or selling it
-closing a location or region
-relocating
-changes in management
-going from labor intensive to capital intensive

recognition criteria for restructuring provision:
same general criteria
AND
1) detailed formal plan
(approved by board, reason given, # of locations affected, cost of restructuring, dates of implementation)

+
2) valid expectation (through implementation or announcement)

PROVISION AMOUNT:
-only make provision for directly attributable cost related to restructuring eg. redundancy cost, penalties to land lord
-no provision for ongoing internal cost, eg. training cost, relocation cost.

Question 10

what is the diff between provision and contingent liabilities?

Answer 10

provision is a present obligation
CL is only a possible obligation or
economic outflow not probable or cant be measured reliably.

Question 11

is a board decision a present obligation?

Answer 11

no cuz it can be reversed, until decision is made public or commitment is made, there is no obligation

Question 12

what if it’s not clear if there is a present obligation?

Answer 12

in this rare case, if at reporting date it is more likely than not that there is a presetn obligation, a past event should be deemed to give rise to a P.O. this is a matter of judgement, all evidence and expert opinions shud be taken into account.

Question 13

is it necessary to know the identity of the party to whom present obligation is owed, for it to exist?

Answer 13

no

Question 14

there might be a legal case of X company.
lawyers say in 2016 they wont be liable but in 2017 it is probable they might be. is there a present obligation in 2016? should a provision be made?

Answer 14

in 2016, there is no present obligation. so no provision.

in 2017 there is a present obligation so a provision should be recognised,

Question 15

a retail store has a return policy,not a legal obligation. is there a present obligation?

Answer 15

yes, there is a constructive obligation. past conduct has created valid expectation for customer.
proable outflow of resources
a provision shud be recognised for best estimate of cost of refund.

Question 16

company causes contamination. no environment laws in country. company has a published environmental policy of clean up, and a record of honoring this.
is there a present obligation?

Answer 16

yes, there is a constructive obligation,
obligating event is contamination
entity’s conduct has created a valid expectation.

provision shud be recognised at best estimates of cost of cleanup.

Question 17

can provision be made for fire or flood or other business risk?

Answer 17

no cuz no past event gives rise to a present obligation at reporting date.

Question 18

what to do if an entity can’t provide an estimate for provision?

Answer 18

if no estimate can be made, liability cant be recognised, so a contingent liability has to be disclosed.

Question 19

can contingent assets and liabilities be recognised in FS?

Answer 19

no, they cant

Question 20

when is a contingent liability not disclosed?

Answer 20

it is disclosed unless the chances of economic outflow are REMOTE.

Question 21

what are contingent assets?

Answer 21

they usually arise from unplanned or unexpected events which give rise to to possibility of inflow of economic benefits. (eg. pursuing a claim through legal process)

if income is virtually certain, the asset is not contingent and it is recognised in FS.

if inflow is PROBABLE, it is just disclosed

Question 22

what happens if there is time value of money

Answer 22

if its material a discount factor should be applied.
rate should be pre tax that reflects current market rate.

Question 23

if there is evidence that future events such as change of law will happen then?

Answer 23

this should be reflected in measuring provision.

Question 24

is provision measured before or after tax

Answer 24

before tax

Question 25

in what ways can provision cost may be reimbursed?

Answer 25

1) an insurance payout
2) supplier warranty
3) counter claim

Question 26

under what condition can reimbursement of provision settling cost be recognised?

Answer 26

if it is virtually certain that it will be reimbursed by a third party.
eg. iphone fell and broke, and there is a warranty. or car accident and insurance etc.

Question 27

what is the accounting treatment of reimbursement of provision?

Answer 27

in PnL, the reimbursement can be set off against provision amount and net amount can be presented
in SOFP, reimbursement is to be classified as an asset, clearly not exceeding the provision amount

Question 28

what happens when costs actually incur related to the item for which provision has been made?

Answer 28

the costs are charged against the provision.
provision carrying amount is reduced.
-

Question 29

how often should recognised provisions be reviewed?

Answer 29

at each reporting date. they shud be reviewed and adjusted to reflect the current best estimate. if the recognition criteria is no longer met, it should be reversed.

Question 30

what is the accounting treatment of discounted provision?

Answer 30

if the provision was discounted to reflect the time value of money, its carrying amount is increased each year to reflect the passage of time, the increase is recognized as a finance cost.

check 15.3.3

Question 31

can you make a provision for future operating losses? give reason

Answer 31

no!
cuz its not a past event
there is no obligation

Question 32

can you make a provision for an onerous lease contract?

Answer 32

no because liability is already recognised.
IF the lease has not yet commenced then it can be recognised as provision

Question 33

how is the amount for provision of onerous contract decided?

Answer 33

it is the lower of:
the cost of fulfilling the contract
any penalty arising from not fulfilling it

Question 34

can a provision be made for restructuring costs? what is the criteria?

Answer 34

a provision for restructuring liability is only recognised once critera is met.

just a management decision is not a constructive obligation because it can be reversed.

criteria for it to be a constructive obligation:
-there is a detailed formal plan
-there is a valid expectation: i.e implementation is started (sale of assets) or announcements have been made to ppl effected.

Question 35

what must be identified in a detailed formal plan for restructuring?

Answer 35

• the business or areas of business concerned
  -the main affected locations
  -the location, function and approx number of employees who will be compensated.
  -expenditures that will be undertaken
  -date when implementation will start.

Question 36

is the announcement of sale of division a constructive obligation?

Answer 36

no, unless there is a binding sales agreement.

Question 37

what is the treatment of restructuring provision in business combinations?

Answer 37

it is only recognised if at reporting date there is an existing liability on acquiree’s FS. this is unlikely in most business combinations.

Question 38

what costs can and cannot be recognised in restructuring provison?

Answer 38

only costs that are necessary for restructuring and not related to ongoing activities can be recognised.

costs like
-training and relocation of staff
-marketing costs
-cost of investment in new systems and networks
-operating losses up to the restructuring date.
can not be recognised..

Question 39

what are decommissioning costs? and should we provide for them?

Answer 39

when an entity is committed to spend money when closing an asset. eg. in oil industry after drilling a site, you have to clean up and restore it to it’s natural condition.

a provision must be made when there is a present obligation. it could be made whenever, day 1 or part way through life of asset.

Question 40

what is the accounting treatment of decommissioning costs?

Answer 40

INITIALLY it will be recognised at present value.
the double entry will be:
ASSET DEBIT (IAS 16)
PROVISION CREDIT
-
AS TIME PASSES, PROVISION WILL BE INCREASED AT EACH YEAR END.
.
THIS INCREASE WILL ADDED IN FINANCE COST IN INCOME STATEMENT.

DEBIT- FINANCE COST
CREDIT- PROVISION.

Each year end, decomissioning cost will be depreciated also:
DEBIT- depreciation
credit- acc. depreciation in SOFP.

Question 41

how do we calculate the discount factor?

Answer 41

1/ (1+int rate)^time
discount factor will be multiplied by amount to show present valu.

Question 42

what is self insurance?

Answer 42

insurance costs have become high so businesses may want to “self insure”
rather than pay insurance premiums, they may set aside funds for a rainy day.
this is fine but a provision for this is not allowed.
.
if this was permitted, profits could be manipulated. (big bath)

Question 43

what is substancial expenditure?

Answer 43

some assets require this major expenditure every few years for refurbishment or replacement of major components. (this is diff from routine repairs)
these costs can not be provided for. IAS 16 applies to this.

Question 44

what is the logic behind not making provision for substancial income? even if it’s a legal requirment like aircraft?

Answer 44

because there is no obligation. even if it’s a legal requirement like aircraft part replacement, co. can choose to just sell the aircraft. there is no present obligation.
the depreciation takes account it’s consumption

Question 45

what disclosure should be made for each class of provision?

Answer 45

1-balance b.d and c.d
along with additional provision during the year, it’s amount, any reversals, increase due to discounting (time value of money)
2- nature of obligation and expected timing of expenditure
3- explain any uncertainties in timing or amount
4- any expected reimbursements

Question 46

what disclosures should be made for contingent liabilities?

Answer 46

if chances of it are remote dont disclose.
if probable, possible etc, disclose:
description of nature of liablity.
if applicable:
the uncertainties which might affect outcome
estimate of financial effect
possibility of reimbursement

Question 47

what disclosures to be made for contingent asset?

Answer 47

description of nature
any financial effect estimates.

Question 48

what does serious prejudice mean?

Answer 48

if some or all info about a certain matter may harm company rep, harm its ability to negotiate, it may not be disclosed.
entity shud just explain:
general nature of dispute
fact and reason why info has not been disclosed.