Liabilities and provisions

Question 1

What IFRS standard deals with Provisions?

Answer 1

IAS 37

Question 2

What is the Liability definition?

Answer 2

A liability is a present obligation arising from past events the settlement of which is expected to result in an outflow of economic benefits

Question 3

When do you recognize a liability?

Answer 3

When the definition and recognition criteria are met

Question 4

What is the recognition criteria of a liability?

Answer 4

1) The outflow of economic benefits must be probable
2) The amount must be measurable

Question 5

What is the provision definition?

Answer 5

A provision is a liability of uncertain timing or amount

Question 6

What types of present obligations exist for a provision?

Answer 6

1) constructive obligation
2) Legal obligation

Question 7

How does a constructive obligation arise?

Answer 7

It arises from past practices, published policies, or public announcements giving rise to a valid expectation on other parties.

Question 8

What is the Recognition criteria for provisions?

Answer 8

1) The Outflow of FEBs are probable
2) A reliable estimate
of the amount can be made

Question 9

What is the amount of the provision based on?

Answer 9

It is based on the best estimate of consideration required to settle the obligation at reporting
date.

Question 10

What is the best estimate of a provision based on?

Answer 10

It is based on:

1) the judgement of management,
2) past experience of similar transactions,
3) reports of experts, and
4) events after reporting period.

Question 11

When is discounting a provision required?

Answer 11

Discounting provision to PV is required where the effect is material (using the pre-tax rate)

Question 12

Can a provision be recognized for future operating losses? Why?

Answer 12

No provision is to be recognized for future operating losses because there is no past obligating event
.

Question 13

What may an expectation of future operating losses indicate?

Answer 13

An expectation of future operating losses may
indicate that an asset is impaired, thus necessitating
impairment testing.

Question 14

What is an onerous contract?

Answer 14

An onerous contract is one where unavoidable costs
of meeting the obligations under the contract are
greater than benefits to be received.

Question 15

Are onerous contracts provisions?

Answer 15

Yes. If a contract is onerous, the present obligation under
the contract should be recognized as a provision

Question 16

What amount is recognized for an onerous contract?

Answer 16

The amount to be recognized as a provision is the least net cost of exiting the contract, which is the
lesser of:

a) The cost of fulfilling the contract; and

b) Any compensation or penalties arising from failure to fulfill the contract

Question 17

When does a present constructive obligation to restructure exist?

Answer 17

It exists when an entity (at B/S date)

1) Has a detailed formal restructuring plan (i.e., location of part of
business affected, No. of employees, expenditures and timing of
the plan); AND

2) Has raised a valid expectation in those affected (by either starting
to implement plan OR by announcing or communicating its main
features to those affected).

Question 18

What are qualifying restructuring costs?

Answer 18

Only costs that are directly and necessarily caused
restructuring are included
by the (e.g. costs of making employees redundant and terminating leases ).

Question 19

What costs don’t qualify as restructuring costs?

Answer 19

1) Costs that are associated with on going activities
are excluded (e.g., retraining or relocating continuing staff, marketing or investment in new systems and distribution networks).

2) Any gain from expected disposal of assets must
NOT be included in the restructuring provision

Question 20

When restructuring by sale, when is a provision recognized?

Answer 20

Recognize a provision only once a binding sale
agreement has been signed.

Question 21

For provisions, what should be disclosed?

Answer 21

For each class of provision
, disclose:

• Carrying amount at the beginning & end of the period;
• Additions made during the period;
• Amounts used during the period (incurred & charged);
• Unused amounts reversed during the period; and
• The unwinding of the discount during the period and effects of change in the discount rate.

NOTE: Comparative information is not required for the above items

• Description of nature of provision & timing of outflows.
• The uncertainties re amount or timing of outflows.
• The amount of any re-imbursement.

Question 22

For contingent liabilities, what should be disclosed?

Answer 22

For each class of contingent liability, disclose:

• A brief description of the nature of the contingent liability and, where applicable:

– An estimate of its financial effect;

– An indication of the uncertainties relating to
the amount or the timing of any outflow; and

– The possibility of any re-imbursement.

Question 23

Provide two reasons why it may be necessary for a company to restructure its operating processes,
units or structure.

Answer 23

1) To enable the company to focus on its core-business

2) To improve performance by disposing a loss making operation/division

3) To improve efficiency by either:

(a) removing a layer in the management structure or

(b) moving
operations from a region /country with high operating costs to one with low operating costs

Any other valid reason.

Question 24

explain briefly the term
“income smoothing” and provide one reason why companies engage in such a practice.

Answer 24

Income smoothing refers to the management or manipulation of earnings so as to:

(a) report earnings
that reflect a steady growth over time or

(b) avoid reporting exceptionally good earnings in one year and exceptionally bad earnings in another year

This is done in order to minimize the volatility (risk)
of the share price