Week 2 - IAS 37 - Provisions, contingent liabilities and assets

Question 1

Fair Value of a Lease

Answer 1

If life of equipment matches the term of the release with no residual value remaining it is like lessee has used a loan to purchase the equipment. SO…

Fair Value of the Lease = Present Value of minimum Lease Payments (discount back to present value)

Find the implied interest rate, which can be done by rearranging the formula above. FV of lease/Lease payments = x
Imput ‘x’ into annuity table and will get the implied interest rate
e.g. £33,846 = 13,610 * ‘x’
33,846/13,610 = 2.487
Plug 2.487 into annuity table to get implied interest rate of 10%

Use annuity factor to get FV

Question 2

2 Fundamental Characteristics of Financial Information (always come up in exams so learn)

Answer 2

Relevance - Info must be appropriate for the decisions which users need to make

Faithful Representation - Accounts must give a ‘true and fair’ view of how the reporting entity is performing

Question 3

4 Further Enhancing Characeristics of Financial Info

Answer 3

• Comparability - Users need to be able to compare different organisations in order to make decisions
• Verifiability - Info provided should be able to be checked. e.g. Inventory could be examined by auditors using source documents
• Timeliness - Info provided soon enough after the accounting period to still be useful
• Understandability - Clear and simple for users to interpret

Question 4

Purpose of Financial Accounting

Answer 4

To provide financial information about the reporting entity that is useful to existing and potential investors or creditors/lenders in making decisions about providing resources to the entity

Question 5

Provision

Answer 5

a liability of uncertain timing or amount

More than 50% likelihood of transfer of economic benefits/ Probable. Provision recognised in financial statements as a liability.

e.g. A provision for restructuring costs, where the entity has a formal plan it started to implement (like dismantling plant)

Question 6

Contingent Liabilities

Answer 6

a present obligation that arises from past events but is not recognised because:
it is not probable that a transfer of economic benefits will be required to settle the obligation

Less than 50% likelihood of transfer of economic benefits. POSSIBLE’ wording in Q

Question 7

Contingent Assets Definition

Answer 7

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

No asset recognised in financial statements. Disclosure of contingent asset in notes.

Question 8

Things included in PPE Value
3

Answer 8

Costs of transporting equipment to location and preparing it for use is included in PPE value.
Cost of loan used to buy PPE (if any)
Any removal costs in the future. DISCOUNT BACK TO PRESENT VALUE (removal costs also need to be put as Provision in Non-current Liabilities)

Question 9

How to account for government grants
2 methods

Answer 9

Reduce cost of asset by the grant.
OR
Can create a deferred credit in the SoFP under Non-current liabilities. Amortise this over time, releasing credits (incomes) to the Income Statement. If this method is used, obvs the depreciation per year is higher than the other method (because the initial asset value is measured as higher), this is counteracted by the release of income from the deferred credit, making the net impact on the Income statement the same.

Question 10

Provisions: ‘Possible’ vs ‘Probable’ in question wording

Answer 10

Possible: Contingent liability. No liability in statements, disclosure in notes
Probably: Put provision in liabilities of Balance Sheet.

Question 11

When assessing if a Provision or Contingent Liability should be used, we must ask…
2

Answer 11

Is there an obligating event. For it to be an obligating event, there must be NO REALISTIC ALTERNATIVE to settling the payment caused by the event.
Also must be reliably measurable or else cant be a provision, contingent liability, or asset

Question 12

Deciding if is a Contingent Asset

Answer 12

Virtually certain = put it as an asset
Probable - No asset, Disclosure of contingent asset in notes.
Possible/Unlikely - No asset, no disclosure of contingent asset

e.g. if a firm is suing and expects to receive £1m, deemed probable by the lawyers, we must put it as a contingent asset

Question 13

Show how lease payments will be reflected in the accounts

Answer 13

Find implied interest rate of loan.: FV of lease = minimum lease payments discounted to PV
Rearrange to get number to plug into tables for implied interest rate

Create a table: These are column titles not rows
lease Period
Liability before payment
Rental payment
New liability at end of period (reduce liability by rental payment)
Finance charge (e.g.10% of new liability - if that is implied interest rate calculated)
Liability before payment

SoCI
New table: Year / Finance charge / Depreciation / Total
Total charge to the SoCI is the totals added together

Then draw up quick section of SoFP for assets
Assets
Equipment: FV of equipment and stays the same each year
Less: accumulated depreciation: (increases every year)
Total:

Liabilities
Finance lease obligations: Liability at end of reporting period from the first table created