7. Liabilities

Question 1

How do you initially measure a provision according to IAS 37?

Answer 1

Provision = Expected expenditure required to settle the obligation, based on the best estimate at the reporting date.

Question 2

How do you calculate the expected value of a provision when there are multiple possible outcomes?

Answer 2

Expected Value = Σ(Probability * Possible Outcome), where each possible outcome is weighted by its probability.

Question 3

How is a provision recorded in accounting?

Answer 3

Provision Expense / Provision,
recognizing the obligation in financial statements.

Question 4

What is the present value formula for a provision when the time value of money is material?

Answer 4

Present Value = Future Expenditure / (1 + Discount Rate)^n, where n is the number of periods until settlement.

Question 5

How do you record an accrual for an unpaid invoice?

Answer 5

Expenses / Accrued Expenses,
recognizing an expense and liability for unpaid invoices.

Question 6

How does a constructive obligation differ from a legal obligation?

Answer 6

A constructive obligation arises from a company’s actions, such as established practices or statements, that create an expectation to fulfill an obligation, while a legal obligation is enforceable by law or contract.

Question 7

How do you account for a reimbursement related to a provision?

Answer 7

Reimbursement Receivable / Provision,
recognizing the receivable if reimbursement from a third party is virtually certain.

Question 8

How do you apply a risk adjustment when measuring a provision?

Answer 8

Adjusted Provision = Provision + Risk Factor, where the risk factor accounts for uncertainties related to the obligation, increasing the provision value to reflect potential risks.

Question 9

How do you recognize a provision reversal if the obligation is no longer probable?

Answer 9

Provision / Provision Expense, removing the provision from the financial statements as the obligation is no longer expected to result in an outflow.

Question 10

How is a provision for an onerous contract initially measured?

Answer 10

The provision is measured as the lower of the cost to fulfill the contract or the penalty for non-fulfillment, ensuring that the liability reflects the least costly option for the company.

Question 11

How would you calculate the present value of a long-term provision in uncertain market conditions?

Answer 11

Present Value = Future Expenditure / (1 + Adjusted Discount Rate)^n, where the discount rate is adjusted for market risks, reflecting uncertainties in the provision’s future outflow.

Question 12

How does the concept of “most likely outcome” apply when estimating a provision?

Answer 12

The “most likely outcome” is used when a single probable outcome is evident, rather than multiple scenarios; this approach simplifies the provision estimate to the single highest-probability outcome.

Question 13

How do you determine whether to recognize a provision or disclose a contingent liability?

Answer 13

Use a decision tree: recognize a provision if an outflow of resources is probable and measurable; disclose a contingent liability if the obligation is possible but not probable or not measurable.

Question 14

How do you account for changes in the discount rate for an existing provision?

Answer 14

Adjust the present value of the provision by recalculating it using the new discount rate and recognize the change as an adjustment to the Provision Expense or directly in equity, depending on the accounting policy.

Question 15

How would you account for a potential liability related to ongoing litigation?

Answer 15

Assess the likelihood and possible outcomes; if an outflow is probable, recognize a provision (Provision Expense / Provision). If it’s only possible, disclose it as a contingent liability with details of potential impact.

Question 16

How would you assess the impact of a change in the discount rate on long-term provisions and financial statements?

Answer 16

Recalculate the present value of the provision with the new discount rate, adjusting the Provision and Provision Expense accounts. This impacts financial statements by increasing or decreasing the liability and affecting profit, depending on the direction of the rate change.

Question 17

How do you determine the best estimation method for provisions involving significant uncertainty, like environmental liabilities?

Answer 17

Evaluate the use of expected value vs. most likely outcome based on the nature of the liability. For highly uncertain scenarios with multiple outcomes, the expected value approach is more reliable, as it weights each possible outcome by its probability.

Question 18

How would you account for reimbursement rights for a provision that involves high uncertainty in collection?

Answer 18

Record the reimbursement only if collection is virtually certain (Reimbursement Receivable / Provision, amount); otherwise, disclose it as a contingent asset. If reimbursed, update financial statements to reflect both the provision and the offsetting receivable.

Question 19

How would you apply risk adjustments to provisions when future events carry significant variability?

Answer 19

Increase the provision by a risk factor to account for potential adverse outcomes, ensuring that the estimated provision reflects the upper range of potential costs. This is especially relevant for long-term obligations with high risk exposure.

Question 20

How would you evaluate an onerous contract for provision recognition if future costs fluctuate significantly?

Answer 20

Calculate the provision as the lower of the fulfillment cost or the exit penalty based on current estimates. Regularly reassess as market costs change, ensuring the provision remains aligned with the most cost-effective option for the company.

Question 21

How do you record the initial recognition of a provision for an estimated legal settlement?

Answer 21

Provision Expense (PL) / Provision (BS), amount.

Question 22

How do you record an accrual for wages earned by employees but not yet paid?

Answer 22

Wages Expense (PL) / Accrued Wages (BS), amount.

Question 23

How do you account for the receipt of reimbursement related to a previously recognized provision?

Answer 23

Cash (BS) / Reimbursement Receivable (BS)

Question 24

How do you record the reversal of a provision that is no longer probable?

Answer 24

Provision (BS) / Provision Expense (PL)

Question 25

How do you record an increase in the provision due to changes in estimated costs?

Answer 25

Provision Expense (PL) / Provision (BS)

Question 26

How do you account for a warranty provision at the time of sale?

Answer 26

Warranty Expense (PL) / Warranty Provision (BS), amount.

Question 27

How do you record the payment of an accrued expense that was previously recognized?

Answer 27

Accrued Expense (BS) / Cash (BS), amount.

Question 28

How do you record a provision for an onerous contract where expected costs exceed expected benefits?

Answer 28

Onerous Contract Expense (PL) / Provision for Onerous Contract (BS), amount.

Question 29

How do you account for the increase in a provision when the time value of money is applied?

Answer 29

Interest Expense (PL) / Provision (BS), amount, reflecting the unwinding of the discount on the provision.

Question 30

How do you record a write-off of a provision when the obligation is settled?

Answer 30

Provision (BS) / Cash (BS), amount, removing the liability from the balance sheet.