Chapter 5 - Recognizing & Reporting Assets & Liabilities

Question 1

What is a provision?

Answer 1

A liability where the timing or amount involved is uncertain.

Question 2

A provision should be recognised when all of the following criteria are met:

Answer 2

• there is an obligation arising from a past event (>50 % chance that it exists)
• an outflow of resourced is probably needed to settle the obligation (unavoidable)
• a reliable estimate of the obligation can be made

Question 3

What are the certain criteria for provisions that are related to business restructuring?

Answer 3

A constructive obligation only exists if there is a formal, detailed restructuring plan that has either been communicated to those affected or started to be implemented by the end of the reporting period. Only direct costs associated with the restructuring can be included in the amount of the provision.

Question 4

How is a provision accounted for in the financial statements?

Answer 4

The income statement is charged with an expense of the amount of the provision, and the same amount is a liability in the balance sheet. Once recognised, it should be reviewed at the end of each reporting period to see if there has been any changes.

Question 5

What is a contingent liability?

Answer 5

There is uncertainty regarding timing and/or amount, but not to the same degree as a provision. A future outflow is possible but not probable (<50 % chance). At least one of the criteria for provisions must be less than probable.

Question 6

How to we report contingent liabilities?

Answer 6

Given the degree of uncertainty, it is not recognised in the financial statements. Information of this type might however be relevant for user needs, so it should be disclosed in the notes to the financial statements unless the possibility of a resource outflow is remote.

Question 7

What is a contingent asset and how should it be reported?

Answer 7

A possible asset arising from past events, where the existence will only be confirmed by future events not wholly within the control of the business. Since it is not certain that they will lead to an inflow of resources they are not recognised in the financial statements, but if it is probable they should be disclosed as a note.

Question 8

How do we account for a research phase?

Answer 8

Since research can’t be directly related to future economic benefit, they are regarded as an expense in the income statement.

Question 9

What must be demonstrated for an intangible asset arising from the development phase to be recognised in the balance sheet?

Answer 9

All of the following:

• there is technical feasibility for completion of the asset for use or sale
• there is an intention to complete the asset
• there is an ability to use or sell it
• show how the asset will generate probable future economic benefits
• availability of technical, financial or other resources needed for completion
• ability to measure expenditure attributable to the asset in a reliable way

Question 10

What is a lease agreement?

Answer 10

It gives a business right to use and get arising economic benefits from an asset that someone else owns, in exchange for payments.

Question 11

What are benefits of leasing?

Answer 11

• Ease of borrowing - leased asset is a security.
• Cost.
• Flexibility - rapid technology changes.
• Cash flows - avoid large cash flows.

Question 12

How are leases accounted for in the financial statements?

Answer 12

As both an asset and a lease liability in the balance sheet. The asset is initially valued at cost and is treated in the same way as if it way owned. The carrying amount will reflect depreciations made in accordance with rules for PPE. The lease liability is reduced over time to reflect payments that have been made. Interest related to the lease is normally an expense in the income statement.