Chapter 19

Question 1

Where does IAS 37 deal with?

Answer 1

IAS 37 deals with situations where obligations to or from an entity are uncertain in either the existence of an event and/ or the amount of that event. it shows that judgment and estimates play an important role in setting up and measuring a provision.

Question 2

What is the problem without a complete framework?

Answer 2

Without a complete framework for the accounting for and disclosure of provisions, users are not presented with a true and fair view of the state of affairs.

Question 3

What does IAS 37 effectively ban?

Answer 3

• big bath accounting
• creation of provisions where no obligation to liability exists
• the use of provisions to smooth profits.

Question 4

How does IAS 37 define provisions?

Answer 4

IAS 37 now defines provisions as liabilities of uncertain timing and amount.

Question 5

What do provision require?

Answer 5

It also requires disclosure in relation to provisions in order to aid the user’s understanding and present a true and fair view.

Question 6

To whom is IAS 37 applied to?

Answer 6

IAS 37 is to be applied to all entities when accounting for provisions, contingent liabilities and contingent assets, except for those items resulting from executory contracts and those items covered by another Standard.

Question 7

What are executory contracts?

Answer 7

These are contracts where neither party has performed any of its obligations, or where both parties have partially performed obligations to an equal amount.

Question 8

Where does provisions apply to?

Answer 8

• provision for depreciation
• provision for doubtful debts
• provision for impairment.

Question 9

What are provision?

Answer 9

In these cases, the ‘provision’ is adjusting the carrying amount of the asset; it is not a liability of uncertain timing or amount and therefore should not be recognized as a provision but as an adjustment to the value of the asset

Question 10

What is a liability?

Answer 10

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits and can result from a legal obligation or a constructive obligation. An obligation can be either legal or constructive.

Question 11

What is a legal obligation?

Answer 11

A legal obligation is an obligation that derives from a contract (through its explicit or implicit terms), or from legislation, or from other operation of law.

Question 12

What is a constructive obligation?

Answer 12

A constructive obligation arises from the entity’s actions whereby it has indicated to others that it will accept specified responsibilities and, as a result, has created a valid expectation that it will discharge those responsibilities.

Question 13

What is a contingent liability?

Answer 13

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity or
(b) a present obligation that arises from past events but is not recognized because:
1. (i) it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation or
2. (ii) the amount of the obligation cannot be measured with sufficient reliability.

Question 14

When is a contingent liability a provision?

Answer 14

A contingent liability is a provision where one or more of the three requirements is not met. A contingent liability, as defined by IAS 37, is by its very nature a liability, but it is not recognized as such because it is not charged in the accounts; it is only disclosed.

Question 15

What is a contingent asset?

Answer 15

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. A contingent asset is only disclosed in the notes.

Question 16

What requirements does IAS 37 stipulate when recognising a provision?

Answer 16

(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.

Question 17

What is a requirement of IAS 37?

Answer 17

It is a requirement of IAS 37 that provisions be reviewed at each reporting date at the end of the financial period and adjusted where required, and that the expenditure set against a provision is only that in relation to the intent of the provision.

Question 18

What does IAS 37 require?

Answer 18

IAS 37 requires that when determining a reliable estimate this should be ‘the best estimate of the expenditure required to settle the present obligation at the reporting date’

Question 19

When is the best estimate determined?

Answer 19

The best estimate is determined by the judgement of management, supplemented by experience of similar transactions and/or reports from independent experts. The Standard states that these gains must be dealt with in accordance with the Standards dealing with the assets concerned.

Question 20

What does the requirement of the standard mean?

Answer 20

This requirement of the Standard means that we must discount the expenditures required, and the IAS Standards specify the discount rate as a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability.

Question 21

What three specific applications of recognition and measurement of provisions does IAS 37 identify?

Answer 21

1. Future operating losses.
2. Restructuring.
3. Onerous contracts.

Question 22

What are future operating losses?

Answer 22

These do not meet the definition of a liability as there is no present obligation and thus no liability. The loss will be recognized as it occurs. However, the possibility of future losses should lead management to test assets for impairment.

Question 23

What are onerous contracts?

Answer 23

An onerous contract is a contract in which the unavoidable costs of meeting the obligation under the contract exceed the economic benefits to be received under it. These situations can occur when, for example, the economic environment changes and instead of being profit-generating, the contract will be loss-making.

Question 24

What is the only clarification given in the context of an onerous contract?

Answer 24

The only clarification that is given in the context of onerous contracts is that before a separate provision for an onerous contract is established, an entity recognizes any impairment loss that has occurred on assets dedicated to that contract.