Provisions and Contingencies

Question 1

Which IAS covers provisions, contingent liabilities and assets?

Answer 1

IAS 37

Question 2

Why was IAS 37 introduced?

Answer 2

There was little guidance for provisions
- companies would choose to make and then release provisions to smooth out profits

Question 3

Provision definition

Answer 3

liability of uncertain timing or amount

Question 4

What distinguishes provisions from other liabilities?

Answer 4

• trade payables/accruals are certain
• provision there is uncertainty about timing to amount of expenditure

Question 5

Recognition criteria of a provision

Answer 5

1. an entity has a present obligation (legal/constructive) as a result of a past event
2. probable (more than 50%) that a transfer of economic benefits will be required to settle
3. reliable estimate of the obligation

Question 6

Legal Obligation

Answer 6

• arises out of a contract - sold goods with warranty
• or out of legislation - redundancy pay

Question 7

Constructive Obligation

Answer 7

• arises through past behaviour/actions
• where entity has raised a valid expectation that it will carry out a particular action
• ‘reputation with customers’

Question 8

Probable Outflow

Answer 8

• more likely than not to occur
• greater than 50% chance of occurring

Question 9

Measurement of estimate

Answer 9

• amount recognised is best estimate
• of expenditure required to settle present obligation at end of reporting period
• determined by judgement of entity management and experience of similar transactions

Question 10

How does provision change if relating to more than one item?

Answer 10

• one item, best estimate of expenditure used
• lots of items, calculated using expected value approach which is weighted (warranties generally)
• Provision = Probability x expected outcome

Question 11

What is the double entry for a provision?

Answer 11

Dr Expense (SoP/L)
Cr Provision (SoFP) current liability if less than yr, NCL if over a yr

Question 12

Double Entry to increase a provision?

Answer 12

Dr Expense (SoP/L)
Cr Provision (SoFP)
increase by amount of change if related to original provision

Question 13

Double Entry to decrease provision?

Answer 13

Dr provision (SoFP)
Cr Expenses (SoP/L)

Question 14

Disclosure for provisions in financial statements

Answer 14

• reconciliation of carrying amount at begin/end, additional provisions, amounts used
• description of nature
• expected timing of any outflows
• indication of uncertainties
• major assumptions
• any expected reimbursements (insurance?)

Question 15

Contingent Liabilities

Answer 15

• uncertain liability that does not meet three criteria for recognising a provision
• possible obligation arising from past events and existence will only be confirmed by occurrence/non-occurence of one/more uncertain future event
• not wholly within control of entity
  OR
• present obligation that is not probable of an outflow of economic resource/ cannot be measured reliably

Question 16

How should continent liabilities/assets be shown in financial statements?

Answer 16

• disclosed in notes
• not included in numbers at all

Question 17

What does an obligation being remote mean?

Answer 17

• it is to unlikely to be disclosed in notes and so is not mentioned at all

Question 18

What is the flow chart for working out if something is a provision or contingent liability?

Answer 18

Present obli - No - possible obli - no - do nothing
- yes
Probable outflow- No- remote (yes do nothing) (no contingent liability)
- yes
Reliable estimate - no disclose contingent liability
- yes- provide

Question 19

How should a contingent liability/asset be disclosed in financial statements?

Answer 19

• nature of contingent liability
• estimate of financial effect
• uncertainties
• possibility of reinbursement

Question 20

Contingent Asset

Answer 20

• possible asset
• arising from past event
• existence will be confirmed by occurrence/non-occurrence of 1/more uncertain future events
• not wholly within control of entity

Question 21

When should a contingent asset be disclosed?

Answer 21

• if probable that economic benefit will flow to entity
• important to not recognise proper assets until virtually certain as display of prudence