Provisions,contingent liabilities and contingent assets Flashcards
What is a definition of Provision?
A liability of uncertain timing or amount.
What are the 3 conditions according to IAS 37 required before a provision can be recognised?
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.
What is a legal obligation?
An obligation that derives from:
- a contract
- legislation
- other operation of law
What is constructive obligation?
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.
Probable outflow:
If the event is more likely than not to occur. In other words, there is likelihood of an outflow is greater than 50%.
Reliable estimate:
- Use of estimates is essential when preparing financial statements and does not undermine their reliability.
Accounting entry for Provisions:
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
What amount is recognised as provision?
- 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.
Discounting:
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.
When provision involves:
- 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.
Accounting entry to Increase/Decrease Provision:
INCREASE
Debit: Expense
Credit: Provision
DECREASE
Debit: Provision
Credit: Expense/PPE
Accounting entry when a Provision is used:
Debit: Provision
Credit: Cash
Future Operating Losses:
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.
Onerous contracts (Future Operating Losses):
A contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
Measurement of provision Lower of (Onerous contracts):
1.) Net cost of fulfilling the contract
2.) Compensation or penalties arising from failure to fulfil the contract
A lease can only be accounted for as an onerous contract if:
- It becomes onerous before the lease commencement date
- It has been accounted for under the IFRS 16 recognition exemptions and has become onerous.
A provision for Restructuring Costs is recognised only when entity has a constructive obligation to restructure. Only arises where an entity:
- 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.
Restructuring provision should include only direct expenditures arising from restructuring and which are:
- Necessarily entailed by restructuring
- Not associated with ongoing activities of the entity
A restructuring provision does not include such costs as:
- Retraining or relocating continuing staff
- Marketing
- Investment in new systems and distributions networks
What are types of Decommissioning costs:
- 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
What is a Contingent Liability:
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
What will result in an contingent liability:
- 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
Nature of disclosure of contingent liability:
- 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
Contingent Asset:
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.
Contingent assets nature of disclosure:
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
Contingent Assets Need for disclosure:
Users of financial statements need to be aware of potential positive impact on cash flows and profits should the contingent asset become receivable.
