Chapter 12 Provisions and contingencies Flashcards
1.1 Accounting for uncertainty
Sometimes an expense or income may not arise, they are uncertain. IAS 37 provides the rules for accounting uncertainty. IAS 37 says a provision is a liability of uncertain timing or amount. A liability is a present obligation of the entity to transfer an economic resource as a result of past events. The obligation is a duty/responsibility that the entity has no practical ability to avoid.
2.1 Recognition criteria
IAS 37 says a provision should be recognised when an entity has a present obligation as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. If one or more of these conditions is not met, a provision may not be recognised, a contingent liability is more appropriate.
2.2 Measuring a provision
Should be the best estimate of the expenditure required to settle the present obligation at the reporting date. The best estimate is determined by management based on similar transactions in the past and the advice of independent experts. For a single obligation (such as legal case), the most likely outflow will generally be the best estimate. Where the provision involves a large population of items such as warranties, the expected value method should be used to derive the best estimate. The provision should be discounted to present value where the effect of this is material. This will subsequently be unwound.
2.3 Accounting for a provision
The correct accounting entries to set up a provision are Dr Expense (P+L) Cr Provision (SFP). The relevant expense category will depend upon the subject of the provision. The Dr entry for the provision for dismantling costs will be to PPE rather than to the P+L. This will subsequently be released to the P+L through depreciation.
2.4 Accounting for a change in provision
Provisions should be reviewed at each reporting date. If a provision no longer meets the recognition criteria be derecognised. Dr Provision (SFP) and Cr P+L.
If the best estimate of the probable outflow has changed, the provision should be increased or decreased accordingly. For an increase in provision Dr Expense (P+L) and Cr Provision (SFP). For a decrease in provision Dr Provision (SFP) and Cr Expense (P+L).
Only the movement of the provision is accounted for. The provision should be reassessed at the end of reporting period and adjusted for best estimates. This reassessment includes estimated cash flows and any discount rates used.
2.5 Accounting for the use of a provision
A provision may only be used for the expense it was originally created for. Where relevant expenditure is incurred, the double entry to record this is Dr Provision (SFP) and Cr Cash. Any difference between the opening provision and the amount paid should be recognised in the P+L.
3.1 Provisions – expected disposal of assets
Gains and losses from the expected future disposal of assets should not be considered when creating provisions.
3.2 Future operating expenses
No provision may be made for future operating losses because they arise in the future, and therefore do not meet the definition of a liability
3.3 Onerous contracts
IAS 27 defines this as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. Unavoidable costs are the lower of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfil it. A provision for the cost should be recognised as an expense in the P+L in the period when the contract becomes onerous. In subsequent periods, this provision will be reduced by the payments made.
3.4 Provision for restructuring
IAS 37 defines a restructuring as a programme that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity or the manner in which that business in conducted. A provision may only be made if a detailed and approved plan exists, and the plan has been announced to those affected (generally employees). The provision should include direct expenditure arising from restructuring and exclude costs associated with ongoing activities.
3.5 Dismantling and restoration costs
If an obligation exists at the date of acquisition to dismantle/restore an item of PPE at the end of its useful life, then the costs of the site restoration are treated as directly attributable to brining the asset to its present location and condition. They should therefore be capitalised in accordance with IAS 16 PPE. Since these costs will be incurred in the future it will be necessary to discount these costs if considered material by the entity.
4.1 Disclosure
For each class of provision, an entity should provide narrative disclosures including a brief description of the nature of the obligation and expected timing of any resulting outflows of economic benefits, an indication of uncertainties about the amount and timing of outflows and the amount of any expected reimbursement stating the amount of any asset that has been recognised for that expected reimbursement.
5.1 Treatment of uncertain liabilities
The probability of the obligation occurring should be assessed. If it is remote (ignore), possible (disclose as a contingent liability) and probable (provide, assuming all the recognition criteria have been met).
Where a contingent liability is possible, IAS 37 requires that a brief description of the nature of the contingency and an estimate of the financial effect, an indication of uncertainties relating to the amount or timing of any outflow and the possibility of any reimbursement to be disclosed.
6.1 Treatment of Uncertain assets
The probability of the asset occurring should be assessed. If remote and possible nothing is recorded if probable disclose as a contingent asset and if virtually certain recognise the asset. A contingent asset is a probable asset arising from a past event. IAS 37 requires a description of the nature of the asset and an estimate of the financial effect be disclosed. If it is virtually certain that the company will have a benefit that can be reliably measured, an asset can be recognised. The double entry to record this is Dr Receivable and Cr P+L (other income).
7.1 Reimbursement
Sometimes where a company settles a claim, it is reimbursed for this cost by an insurer or supplier. If the reimbursement is virtually certain, and the settlement of the claim upon which the reimbursement depends is probable then the company should record both a provision and associated asset. The asset and liability must be disclosed separately of the statement of financial position, P+L amounts may be netted off and the amount of asset may not exceed the amount of provision.
