Provisions,contingent liabilities and contingent assets

Question 1

What is a definition of Provision?

Answer 1

A liability of uncertain timing or amount.

Question 2

What are the 3 conditions according to IAS 37 required before a provision can be recognised?

Answer 2

1.) Present obligation as result of past event
2.) Probable outflow of economic resources to settle obligation
3.) Reliable estimate can be made of the amount of the obligation.

Question 3

What is a legal obligation?

Answer 3

An obligation that derives from:
- a contract
- legislation
- other operation of law

Question 4

What is constructive obligation?

Answer 4

An obligation that derives from entity’s actions where:
- by an established pattern of past practice, published policies or sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities
-as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

Question 5

Probable outflow:

Answer 5

If the event is more likely than not to occur. In other words, there is likelihood of an outflow is greater than 50%.

Question 6

Reliable estimate:

Answer 6

• Use of estimates is essential when preparing financial statements and does not undermine their reliability.

Question 7

Accounting entry for Provisions:

Answer 7

To CREATE A PROVISION:
Debit: Expense
Credit: Provision
ARISES DUE TO CONSTRUCTION OR ACQUISITION OF NON-CURRENT ASSET, PROVISION SHOULD BE INCLUDED WITHIN ORIGINAL COST OF ASSET.
Debit : Property, Plant and Equipment
Credit: Provision

Question 8

What amount is recognised as provision?

Answer 8

• The best estimate of the expenditure required to settle the obligation at the end of the reporting period.
• It is the amount that the entity would rationally pay to settle the obligation or transfer it to a third party at the end of the reporting period.

Question 9

Discounting:

Answer 9

Provisions are discounted where the effect of the time value of money is material.
Where a provision is discounted,subsequent years, the discount will be unwound which will result in interest being charged to profit or loss as a finance cost.

Question 10

When provision involves:

Answer 10

• Large population = Use Expected Values, taking into account the probability of all expected outcomes
• Single obligation = individual most likely outcome may be the best evidence of the liability.

Question 11

Accounting entry to Increase/Decrease Provision:

Answer 11

INCREASE
Debit: Expense
Credit: Provision
DECREASE
Debit: Provision
Credit: Expense/PPE

Question 12

Accounting entry when a Provision is used:

Answer 12

Debit: Provision
Credit: Cash

Question 13

Future Operating Losses:

Answer 13

Provisions are not recognised for future operating losses. Future operating losses do not meet the definition of a liability or the recognition criteria for a provision.

Question 14

Onerous contracts (Future Operating Losses):

Answer 14

A contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

Question 15

Measurement of provision Lower of (Onerous contracts):

Answer 15

1.) Net cost of fulfilling the contract
2.) Compensation or penalties arising from failure to fulfil the contract

Question 16

A lease can only be accounted for as an onerous contract if:

Answer 16

• It becomes onerous before the lease commencement date
• It has been accounted for under the IFRS 16 recognition exemptions and has become onerous.

Question 17

A provision for Restructuring Costs is recognised only when entity has a constructive obligation to restructure. Only arises where an entity:

Answer 17

• Has a detailed formal plan for the restructuring
• Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement the plan or announcing its main features to those affected by it.

Question 18

Restructuring provision should include only direct expenditures arising from restructuring and which are:

Answer 18

• Necessarily entailed by restructuring
• Not associated with ongoing activities of the entity

Question 19

A restructuring provision does not include such costs as:

Answer 19

• Retraining or relocating continuing staff
• Marketing
• Investment in new systems and distributions networks

Question 20

What are types of Decommissioning costs:

Answer 20

• Dismantling and removing the plant at the end of its useful life
• Restoration of the site for damage caused by constructing the non-current asset
• Restoration of site to rectify damage caused by operation of the plant

Question 21

What is a Contingent Liability:

Answer 21

1.) Possible obligation that arises from past events and whose existence will be confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within control of the entity
2.) Present obligation that arises from past events but is not recognised because:
- it is not probable that an outflow of resources embodying economic benefits will be required to settle obligation
- amount of obligation cannot be measured with sufficient reliability

Question 22

What will result in an contingent liability:

Answer 22

• Obligation that is estimated to be < or = 50% likely to exist
• Present obligation that has < or = chance of requiring an outflow of economic benefits
• Present obligation for which sufficiently reliable estimate cannot be made

Question 23

Nature of disclosure of contingent liability:

Answer 23

• Brief description of nature of contingent liability and where practicable all of the following:
• Estimate of its financial effect
• An indication of uncertainties relating to amount or timing of any outflow
• Possibility of reimbursement

Question 24

Contingent Asset:

Answer 24

A possible asset arising from past events whose existence will only be confirmed by the occurence of one or more uncertain future events not wholly within the control of the entity.

Question 25

Contingent assets nature of disclosure:

Answer 25

Is disclosed where an inflow of economic benefit is probable.
Disclose the following:
- Brief description of nature of contingent asset at the statement of financial position date
- Where practicable, an estimate of financial effect

Question 26

Contingent Assets Need for disclosure:

Answer 26

Users of financial statements need to be aware of potential positive impact on cash flows and profits should the contingent asset become receivable.