l1.2 : provisions, contingencies & events after reporting period

Question 1

state and explain the three requirements that define a liability.

Answer 1

1. present obligation (duty to act or perform a certain way)
2. past event (future commitments not relevant)
3. outflow of economic benefits (cash reduction, transfer of another asset, barter exchange)

definition intentionally broad to ensure no liabilities omitted or hidden

Question 2

state and explain the two requirements for a liability to be recognised.

Answer 2

1. probable outflow (certainty that obligation will result in economic benefit outflow)
2. measured reliably (documented evidence to support amount recorded in FS)

Question 3

define provision according to ias37.

Answer 3

liability of uncertain timing or amount

Question 4

state three examples of provisions according to ias37.

Answer 4

• warranty claims
• refunds for returns
• restructuring costs

Question 5

when have provisions be used?

Answer 5

can be used for profit smoothing. if profits are going to be anamoly high one year, then provision can reduce profit. prevents investors from expecting high profits in following years.

Question 6

state and explain the three criteria for the recognition of provisions according to ias37.

Answer 6

• present obligation from past event
• probable outflow of economic benefits
• measure reliably

Question 7

how is “obligation” defined in ias37?

Answer 7

• legal (contract, legislation)
• constructive (past behaviour / statements that create valid expectation that company will act in certain way)

Question 8

how is “probable” defined in ias37?

Answer 8

more likely to occur than not (>50% chance that entity will transfer resources to another party)

Question 9

how is “reliable measure” defined in ias37?

Answer 9

mgt judgement of similar transactions. must be aware that risk & uncertainty involved.

Question 10

what is a contingent liability?

Answer 10

• not recognised in FS
• may require disclosure (unless remote - extremely unlikely). should include description, estimated financial effect, indiciation of uncertainties, possibility of reimbursement

Question 11

what is big bath accounting?

Answer 11

creation of provisions where no obligation to a liability actually exists. often used to smooth profits

Question 12

what are expected values?

Answer 12

when estimating obligation of a large population of items, all possible outcomes are weighted (using associated probabilities)

Question 13

what is discounting?

Answer 13

used to record present value of expenditure required to settle obligation

Question 14

what is an onerous contract?

Answer 14

contract in which unavoidable costs of meeting obligations exceed expected economic benefits

Question 15

how are unavoidable costs calculated?

Answer 15

lower of :
- costs of fulfilling contract
- compensation / penalties arising from failure to fulfill it

Question 16

state the two requirements for restructuring to be recognised as a provision.

Answer 16

1. detailed formal plan (business concerned, principal locations, employees affected etc.)
2. valid expectation (board decision doesnt give rise to constructive obligation unless, already begun implementation or made public announcement)

Question 16

what is an adjusting event according to ias10?

Answer 16

events that provide evidence of conditions that existed at reporting date. should be reflected in FS. eg. resolution of court case, inappropriate going concern basis

Question 17

what is a non-adjusting event according to ias10?

Answer 17

events that provide evidence of conditions that arose after reporting period. only disclosed if material. eg. dividends proposed, loss or decline in value of assets