Chapter 10 - Provisions and contingencies Flashcards
What is a provision
A liability of an uncertain amount.
Thus a provision must meet a liability definition, and a reliable estimate must be able to be made of the amount.
If a provision does not meet the recognition criteria, it will be regarded as a?
Contingent liability
A provision must be based on a best estimate. This would be from ?
Management who have experience in similar transactions, or independent experts.
Why are future operating losses not regarded as a liability?
Because one of the requirements of a liability is that it is a obligation of which the entity cant avoid. Operating losses can be avoided by simply stopping that operation.
An obligation can be legal or constructive. What do we mean by constructive?
We mean that the obligation is formed by expectations due to previous activities undertaken.
Provision double entry?
Dr Expense
Cr Provision (SPL)
By ye 31 Dec X2, probable likely charge of £4m having to be paid in 2 years time. Discount rate with time is 10%. What are the DEs for X2 and X3
At the end of the 2 years, it would be Dr expense £4m and Cr Provision £4m.
However at present value, at 31 Dec X2, this £4m is worth (4m/1.1) ^2 = £3,305,785
Hence Dr expense Cr prov
31 Dec X3
We increase by 10%, thus 0.1 * 3305785, equalling 330,579
Hence we would Cr Prov and Dr Finance cost
CA of provision is 3305785 + 330579
What is a onerous contract
A contract where the unavoidable costs of meeting the contract exceed the economic benefits expected to be received from it.
A provision for restructuring is commonly examined. This provision can only be made if? What must be included in the provision.
Can only be made if;
- A detailed formal and approved plan exists
- Plan has been announced to those affected.
Provision should include
- Direct expenditure arising from restructuring
- Exclude costs arised with ongoing activities
Dismantling and restoration costs are commonly used in the exam. If there is an obligation to bring the assets to its present condition at end of its useful life, what do we do with this costs?
Treated as directly attributable to bringing the asset to its present condition. Thus can be capitalised.
Jackman plc completed the construction of a production facility on 1 January 20X1 at a cost of £400,000. As part of the granting of the planning permission, it was agreed that Jackman would dismantle the facility and restore the site at the end of its 20 year useful life. Jackman estimates that the cost of this work will be £250,000 and a discount rate of 10% should be used.
Jackman has a year end of 31 December.
Explain the financial reporting treatment for the above issue for the year ended 31 December 20X1
We would normally recognise the asset as 400k - depreciation using the useful life. However, restoration costs are directly attributable and thus we can capitalise. Must discount this with time.
250,000 * (1.1)^20 = £37160 = Cr Prov
Thus at y/e 37160 * 0.1 (unwinding the prov) = £3716. Thus Cr Prov, Dr expense
This the provision, representing the present value of future cashflows Cr Provision 37,160
Hence add this to original cost of capital
400,000 + 37,160 = £437,160
Depreciate over 20 years (437,160 / 20) = £21,858
Overall;
Dr NCA (437,160 - 21,858) = £415,302 (SFP)
Dr Dep expense £21,858 (SPL)
What disclosures are required for a provision?
Description of the nature of the obligation and expected timing of any resulting outflows of economic benefits
Indication of uncertainties about amount and timing of outflows
The probability of the obligation occurring should be assessed. This ranges from?
Remote - do nothing
Possible - disclose as contingent liability (no more than 50% likelehood)
Probable - provide
The probability of an asset should be assessed. This ranges from?
Remote - ignore
Possible - ignore
Probable - disclose as contingent asset
Virtually certain - recognise asset (Dr Receivable, Cr Other Income )
