IAS37

Question 1

Define provision

Answer 1

Provision is a liability of uncertain timings or amount.

Question 2

What were the problems when there was no accounting standard for provisions?

Answer 2

-Provisions were made when expenses were likely, not certain, and later reversed to inflate income.

-Management used “rainy day” provisions to smooth profits—making provisions in good years and reversing them in bad years to boost future profits (Big Bath approach).

Question 3

What are the conditions for recognising a provision for outflow?

Answer 3

1. present obligation (legal or constructive)
2. probable outflow
3. reliable estimate

Question 4

what does probable outflow mean

Answer 4

chances should be more than 50%

remote= less than 10% chances (do nothing)
possible= 10-50% chances (disclose)
probable= 50%-95% (provision)
virtually certain= above 95 (book liability)

Question 5

What are the two types of present obligations?

Answer 5

legal obligation: an obligation that exists by law, eg. law, court order, contract

constructive obligation: is not required by law but it may exist due to valid expectation. eg. past practice, accouncement.

Question 6

What are the two types of statistical tools?

Answer 6

1- most likely outcome. (simply pick up most likely outcome)

2- Expected value analysis (multiply each outcome with its probablity and add together)

Question 7

what is contingent liability

Answer 7

contingent liability: no entry only disclosure

outflow is possible not probable
or
reliable estimate cant be made

Question 8

define contingent asset

Answer 8

inflow of uncertain timing or amount

chances of inlow
remote - do nothing
possible- do nothing
probable - disclosure
virtually certain- recognise receivable

Question 9

what is an onerous contract? what is the accounting treatment?

Answer 9

onerous contract is a loss making contract. i.e when the unavoidable cost of finishing the contract is more than the economic benefit.

a provision may be recognised for onerous contract.
-present obligation exists due to contract.
-if future losses are probable and can be reliably estimated then recognise provision.

provision will be recognised at lower of=
1) PV of future losses
2) penalty to terminate the contract

Question 10

what are restructuring costs.

when may a provision be made for restructuring costs?

what amount will provision be made for?

Answer 10

if restructuring program is happening which will change the scope or manner of business.

eg closing a business line, location, change in management, labor intensive to capital intensive.

provision may be made if all the following are met:
1) detailed formal plan (approved by board)
2) public announcement made to those affected
3) management committed to restructuring

PROVISION AMOUNT: will only be for directly attributable cost. eg. redundancy cost, penalties to land lord

-no provision for ongoing internal cost, eg. training cost, relocation cost.

Question 11

is a board decision a present obligation?

Answer 11

no cuz it can be reversed, until decision is made public or commitment is made, there is no obligation

Question 12

is it necessary to know the identity of the party to whom present obligation is owed, for it to exist?

Answer 12

no

Question 13

there might be a legal case of X company.
lawyers say in 2016 they wont be liable but in 2017 it is probable they might be. is there a present obligation in 2016? should a provision be made?

Answer 13

in 2016, there is no present obligation. so no provision.

in 2017 there is a present obligation so a provision should be recognised,

Question 14

a retail store has a return policy,not a legal obligation. is there a present obligation?

Answer 14

yes, there is a constructive obligation. past conduct has created valid expectation for customer.
proable outflow of resources
a provision shud be recognised for best estimate of cost of refund.

Question 15

company causes contamination. no environment laws in country. company has a published environmental policy of clean up, and a record of honoring this.
is there a present obligation?

Answer 15

yes, there is a constructive obligation,
obligating event is contamination
entity’s conduct has created a valid expectation.

provision shud be recognised at best estimates of cost of cleanup.

Question 16

can provision be made for fire or flood or other business risk?

Answer 16

no cuz no past event gives rise to a present obligation at reporting date.

Question 17

what to do if an entity can’t provide an estimate for provision?

Answer 17

if no estimate can be made, liability cant be recognised, so a contingent liability has to be disclosed.

Question 18

can contingent assets and liabilities be recognised in FS?

Answer 18

no, they cant

Question 19

when is a contingent liability not disclosed?

Answer 19

it is disclosed unless the chances of economic outflow are REMOTE.

Question 20

what happens if there is time value of money

Answer 20

provision should be discounted if time value of money is material

rate should be pre tax that reflects current market rate.

if long term then use rate of high quality corporate bonds

Question 21

if there is evidence that future events such as change of law will happen then?

Answer 21

this should be reflected in measuring provision.

eg. if new law will increase cost of environmental cleanup, then increased cost provision shud be recognised

Question 22

what happens when costs actually incur related to the item for which provision has been made?

Answer 22

the costs are charged against the provision.
provision carrying amount is reduced.

Question 23

how often should recognised provisions be reviewed?

Answer 23

at each reporting date. they shud be reviewed and adjusted to reflect the current best estimate. if the recognition criteria is no longer met, it should be reversed.

Question 24

can you make a provision for future operating losses? give reason

Answer 24

no!
cuz its not a past event
there is no obligation

Question 25

what must be identified in a detailed formal plan for restructuring?

Answer 25

• the business or areas of business concerned
  -the main affected locations
  -the location, function and approx number of employees who will be compensated.
  -expenditures that will be undertaken
  -date when implementation will start.

Question 26

is the announcement of sale of division a constructive obligation?

Answer 26

no, unless there is a binding sales agreement.

Question 27

what are decommissioning costs? and should we provide for them?

Answer 27

when an entity is obligated to pay for decommissioning / compulsory disposal cost (for eg. in oil industry after drilling a site, you have to clean up and restore it to it’s natural condition)

a provision must be made when there is a present obligation. it could be made whenever, day 1 or part way through life of asset.

Question 28

what is the accounting treatment of decommissioning costs?

Answer 28

-Recognise provision at PV of future cost + add to cost of asset

-Unwinding of liability will be done each year which will increase the provision by the interest amount
dr. interest exp
cr. provision

this decommissioning cost will also be depreciated as it is capitalized.

DEBIT- depreciation
credit- acc. depreciation in SOFP.

Question 29

how do we calculate the discount factor?

Answer 29

1/ (1+int rate)^time
discount factor will be multiplied by amount to show present valu.

Question 30

what is self insurance?

Answer 30

insurance costs have become high so businesses may want to “self insure”
rather than pay insurance premiums, they may set aside funds for a rainy day.
this is fine but a provision for this is not allowed.
.
if this was permitted, profits could be manipulated. (big bath)

Question 31

some assets require this major expenditure every few years for refurbishment or replacement of major components. is provision allowed for this?

Answer 31

no as present obligation does not exist, as asset can be sold

Question 32

what disclosures are required for provisions?

Answer 32

-nature of provision
-expected timing
-amount
-movement of balance
-reimbursements if expected

Question 33

if disclosure would harm the company’s reputation then?

Answer 33

no exemption from disclosure however there is option of not disclosing certain details if it is detrimental.

nature of liability must be disclosed however just explain general details without revealing sensitive information.

Question 34

warranty provisions working

Answer 34

opening warranty provision
add: current yr sales provision
less: utilized provision
less: expired provision
=closing warranty provision