Provisions and Contingent Liabilities

Question 1

What is a liability?

Answer 1

– a present obligation
– to transfer economic resources in the future
– as a result of past events

Question 2

What types of present obligations are there?

Answer 2

• Legal: arising from a contract.
  –
  Equitable: arising from normal business practice or custom.
  –
  Constructive: arising from established pattern of past practice.

Question 3

When does a present obligation exist?

Answer 3

Only where the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation.

Question 4

What is a provision?

Answer 4

A subset of liabilities, defined as a liability of uncertain timing or amount.

Indicates that there is some uncertainty in terms of timing or amount (but not enough of it that could result in failure to meet the recognition criteria of relevance and faithful representation).

Question 5

What is the difference between other liabilities and provisions?

Answer 5

Uncertainty relating to either the timing or the amount.

Question 6

What is the three criteria for recognising provisions?

Answer 6

1. Present obligation as a result of a past event.
2. Probable outflow of resources to settle.
3. Amount of obligation can be reliably estimated.

Question 7

What are the two types of contingent liabilities?

Answer 7

1. A possible obligation whose existence will be confirmed only by the occurrence/non-occurence of one or more uncertain future events not wholly in control of the entity.
2. A present obligation that is not recognised because:
   - it is not probable an outflow of resources will be required to settle the obligation or
   - the amount cannot be measured reliably

Question 8

Are contingent liabilities recognised in the financial statements?

Answer 8

No, they must be disclosed in the notes to the financial statements.

Question 9

When the probability of a possible obligation is judged to be remote, is it disclosed as a contingent liability?

Answer 9

No, because since the chance of it occurring is close to zero, it is not material enough for users to care.

Question 10

What is a business combination?

Answer 10

A transaction or other event in which an acquirer obtains control of one or more businesses.

Question 11

Is a business a group of assets?

Answer 11

No, it is:
- An integrated set of activities and assets.
- Capable of being conducted/managed to provide a return in the form of dividends, lower costs or other economic benefits.

Question 12

What are the key differences between a business and non-business acquisition?

Answer 12

Business combination: assets and liabilities are measured at fair value. Goodwill may come about (or less frequently, a bargain purchase).

Non-business combination: assets acquired are measured at cost.

Question 13

What are the two conditions required for an acquisition to be considered a business combination?

Answer 13

• The net assets acquired must be a business.
• The acquirer must gain control of that business.

Question 14

What is a direct acquisition?

Answer 14

• An acquisition where the acquirer purchases assets, and maybe assumes liabilities of the acquiree.
• Acquirer recognises assets and liabilities acquired in its own accounts.
• The receipt of the acquisition consideration is recognsied by the acquiree in exchange of the net assets and then liquidates the business sold.

Question 15

What is an indirect acquisition?

Answer 15

• An acquisition in which the acquirer purchases sufficient shares in the acquiree to obtain control of the acquiree.
• The acquirer recognises an investment asset equal to the consideration transferred;
• The acquiree does not need to recognise anything and will continue to operate under the control of the acquirer;
• Consolidated financial statements will need to be prepared.

Question 16

What is fair value?

Answer 16

It is an exit price, that is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Question 17

What is the fair value of consideration transferred?

Answer 17

The sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree and the equity interests issued by the acquirer.

Question 18

What is consolidation?

Answer 18

The process of combining the financial statements of individual entities under the control of an entity.

Question 19

What is a group?

Answer 19

• AKA economic entity
• Comprises different legal entities, including the parent and all its subsidiaries.

Question 20

What is a parent?

Answer 20

• An entity that controls one or more entities

Question 21

What is a subsidiary?

Answer 21

A legal entity controlled by another entity.

Question 22

What is the definition of control?

Answer 22

An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.

Question 23

How does power arise and when does it exist?

Answer 23

It arises from existing rights. Most rights arise from a legal contract.

Power is assumed to exist when the investor owns, directly or indirectly, more than half of the voting rights of an entity unless there is evidence to the contrary.

It can also exist when the investor holds no more than half of the voting rights of an investee.

Question 24

What is power?

Answer 24

The ability to direct. In other words, the rights that give power must be substantive - the holder must have the practical ability to exercise the rights.

Question 25

When does a holder of rights not have power?

Answer 25

When the rights are purely protective.

Question 26

What are protective rights?

Answer 26

Rights designed to protect the interest of the party holding those rights without giving the part power over the entity to which the rights relate.

Question 27

What are consolidated financial statements?

Answer 27

The financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity”