Ch 6. Provisions Contingencies and Events after the Reporting Period Flashcards
Define a provision?
and
Compare the difference to a Liability?
IAS 37 (para 14) requires that a
Provision should be recognised when and only when:
- ‘Entity has a present obligation (legal or constructive) as a result of a past event
- Probable that an outflow of resources will be required to settle the obligation
- Reliable Estimate can be made of the amount of the obligation’.
An obligation is something that cannot be avoided:
- A constructive obligation arises when an entity’s past practice or published policies creates a valid expectation amongst other parties that it will discharge certain responsibilities.
- A legal obligation arises from a contract or from laws and legislation.
The difference with a liability:
Liability Definition
A Present obligation of the entity to transfer an economic resource as a result of past events. - Specific Amount by a Specific Date
A Provision is the same as a liability, but it is uncertain of the timing and the amount to be transferred.
Examples of provision:
Accruals
Asset impairments
Bad debts
Depreciation
Doubtful debts
Guarantees (product warranties)
Income taxes
Inventory obsolescence
Pension
Restructuring Liabilities
Sales allowances
How are provisions Measured?
Consider:
Judgements
Discounting
Provisions are measured at the best estimate of the expenditure required to settle the obligation as at the reporting date.
The best estimate of a provision will be:
- Most likely amount payable for a single obligation (such as a court case)
- An expected value for a large population of items (such as a warranty provision).
An entity should use its own judgement in deriving the best estimate, supplemented by past experience and the advice of experts (such as lawyers).
If the effect of the time value of money is material, then the provision should be
discounted to present value.
The discount rate should be pre-tax and risk-specific.
How are Provisions subsequently Remeasured?
Provisions should be remeasured when new information has come to light to reflect the best estimate of the expenditure at each reporting date.
Changes in the estimate should be reflected through the P/L.
Dr Provision Expense(P/L)
Cr Provisions (SFP)
If a provision has been discounted to present value, then the discount must be unwound and presented in finance costs in the statement of profit or loss:
**Dr Finance costs (P/L) Cr Provisions (SFP)**
How are the following situations accounted for?
Reimbursements of provision to be paid (Insurance payouts)
Recognising a provision as a part of a capitalised asset (Restoration costs)
Derecognitions of a provision
- *1 .3 Reimbursements**
- *Some or all of the expenditure needed to settle a provision may be expected to be recovered from a third party, eg an insurer.**
Recognised: only when it is virtually certain that reimbursement will be received if the entity settles the obligation.
1 .4 Recognising an asset when creating a provision
An asset can only be recognised where the present obligation recognised as a provision gives access to future economic benefits (eg decommissioning costs could be on IAS 16 component of cost).
1 .5 Derecognition
If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed (IAS 37: para. 59).
How are future operating losses and Onerous contracts accounted for?
2. 1 Future operating losses
Provisions are NOT recognised for future operating losses.
They do not meet the definition of a liability and the general recognition criteria set out in the standard {IAS 37: para. 63).
2.2 Onerous contracts
IAS 37 defines an
An Onerous Contract: is one which unavoidable costs of completing the contract exceed the benefit expected to be received from the contract.
Simply - When a contract is likely to cost more to meet than the money earned from it.
The Unavoidable costs are recognised as a provision
The amount of the obligation/Provisionioned to pay is the lower of:
- - Costs of fulfilling the contract
- - Penalties from failure to fulfil the contract
How are provisions for future repairs of assets accounted for?
Some assets need to be repaired or to have parts replaced every few years. For example, an airline may be required by law to overhaul all its aircraft every three years.
Provisions CANNOT normally be recognised for the cost of future repairs or replacement parts.
Because there is no current obligation to incur the expense – even if the future expenditure is required by law, the entity could avoid it by selling the asset.
How are Environmental provisions accounted for?
Environmental provisions are often referred to as clean-up/Restoration costs.
Usually related to the cost of decontaminating and restoring an industrial site at the end of its UEL.
A Provision is recognised if a past event has created an obligation to repair environmental damage:
-
Provision created only for the amount that needs to rectify environmental damage that has already taken place.
- There is no obligation to restore future damage because the entity could cease its operations.
-
Merely causing damage or intending to clean up a site does not create an obligation.
- – But an entity may have a constructive obligation to repair damage if it publicises policies that include environmental awareness or explicitly states if it were to clean up the damage caused by its operations.
The full cost of an environmental provision should be recognised as soon as the obligation arises.
- Normally discounted to its present value.
- If the expenditure results in future economic benefits then an equivalent asset can be recognised. This is depreciated over its useful life, which is the same as the ‘life’ of the provision.
How do you account for restructuring costs?
Consider
Definition
Recognition Criteria
Measurement
Definition
Restructuring is a programme that is planned and is controlled by management
and has a materially changes the company, it’s the effect on :
- the scope of a business undertaken in terms of the products or services it provides
- the manner in which a business is undertaken/conducted
IAS 37 says that a restructuring could include:
- Closure or sale of a line of business
- Closure of business locations in a country
- Relocation of business activities from one country to another
When can provisions be Recognised?
Only recognised where there is a constructive obligation to carry out the restructuring
A board decision alone does not create a constructive obligation.
IAS 37 states that a constructive obligation exists only if:
- A detailed formal plan for restructuring, that identifies the businesses, locations and employees affected as well as an estimate of the cost and timings involved
- Employees affected expect the plan will be carried out, because it has been formally announced or because the plan has started to be implemented.
The constructive obligation must exist at the reporting date.
An obligation arising after the reporting date requires disclosure as a non-adjusting event under IAS 10 Events after the Reporting Period.
Measuring a restructuring provision
Direct costs of restructuring. These must be both:
- necessarily entailed by the restructuring
- not associated with the ongoing activities of the entity
Prohibited costs in a restructuring provision:
- Retraining and relocating staff
- Marketing products
- Expenditure on new systems
- Future operating losses (unless these arise from an onerous contract)
- Profits on disposal of assets.
Define Contingent Liability?
How are they accounted for?
Contingent liability is defined by IAS 37 as:
- A Possible Obligation that arises from past events and only confirmed by the outcome of uncertain future events outside of the control of the entity,
or
-
A Present Obligation arises from past events but does not meet the criteria for recognition as a provision, either because:
- Possibly have to make a payment
- (more rarely) it is not possible to make a reliable estimate of the obligation.
Accounted for?
Assess the likelihood of Liability Occurring and then make a disclosure.
- Remote chance - Ignore (no disclosure)
- Possible chance - Disclose
- Probable chance - No longer contingent, it’s now a provision.
What are the Disclosures of Contingent Liability?
Disclosures of Contingent Liability:
For each class of contingent liability, an entity must disclose the following IIAS 37: para. 86):
- *(a) The nature of the contingent liability
(b) An estimate of its financial effect
(c) An indication of the uncertainties relating to the amount or timing of any outflow
(d) The possibility of any reimbursement**
Define a contingent asset?
How is it accounted for?
Contingent Asset is:
- a possible asset that arises from past events
and
- whose existence will be confirmed by uncertain future events outside of the entity’s control.
Simply - An asset that could occur depending on a future event.
Accounted as:-
if the likelihood of the asset occurring is:
- Remote - Ignored e.g e.g I.P infringement lawsuit, entity unlikely
- Possible - Ignored e.g I.P infringement lawsuit, the entity possibly win
- Probably Likely - Disclosed e.g I.P infringement lawsuit, that the entity will probably win.
Define Events after the reporting period are events?
Events after the reporting period are events ‘
That occur between the reporting date and the date on which the financial statements are
authorised for issue’ (IAS 10, para 3).
There are two types of an event after the reporting period:
- adjusting events
- non-adjusting events.
What is an Adjusting event?
Adjusting events are events:
- After the reporting date
- That provides additional evidence of conditions existing at the reporting date and the date the F.S authorised for issue.
The Accounts should be adjusted for the new evidence.
Examples:
- Court Case has been confirmed and confirms a present obligation of a Settlements, (adjustment to Contingent Liability or Contingent Asset)
- Receipt of information indicating that an asset was impaired at reporting date;
- Bankruptcy of a customer that occurs that confirms a loss existed at the reporting date on trade receivables;
- Sales of Inventory after reporting date that gives evidence about their net realisable value at reporting date;
- Discovery of Fraud or Errors that show the financial statements are Incorrect.
What is a Non- adjusting events?
and
How are they treated?
Non-adjusting events are events after the reporting date that concern conditions that arose after the reporting date.
Treated:- as a Disclosure.
IAS 10 requires the following disclosures:
- a description of the event
- its estimated financial effect.
Example:
- a major business combination after the reporting date
- the destruction of a major production plant by a fire after the reporting date
- abnormally large changes in asset prices or foreign exchange rates after the reporting date.
How should Going concern issues arising after the reporting date be treated?
Financial statements should always be prepared as if the entity is of a going concern.
But if management believes this assumption is no longer appropriate (because of an event after the reporting period) then IAS 10 requires:
A fundamental change in the basis of accounting is changed, and the report should be prepared using the “break-up” basis and disclose this fact.
