Week 5.1: IAS 37 Provisions and contingencies Flashcards
What is a provision:
A liability of uncertain timing or amount.
e.g. provision for bad debt:
If you lend a friend money and they say they have a part time job and they will make the money and give it to you. But you realise they are skipping work and going out, you will have doubt that they will not make thar money back and you will not receive that money back. In accounting, that money will be accounted for as provision for bad debt.
What is a contingent liability?
A possible obligation arising from past events whose existence will be confirmed only by future events not wholly within the control of the entity
e.g.
we have doubts that the friend will not be able to pay you back. But they have not started skipping work yet- you do not have any evidence. You just have a doubt.
What is a contingent asset?
A possible asset that arises from past events, whose existence can only be confirmed by uncertain future events and not in control on the organisation.
e.g.
sueing your supplier. You may get an asset from winning the case, but it is not certain.
Why do we need standards for provisions and contingencies?
Uncertainty gives rise to manipulation. e.g. understating provisions to attract investors.
Therefore, need clear guidelines to get a true and fair view.
Where are provisions and contingencies disclosed?
Provisions- Financial statements
Contingencies- In the notes
Degree of probability and provisions for asset
Virtually certain: Recognise asset
More than 50%: Disclose contingent asset by note.
Less than 50%- Do nothing.
Remote: No disclosure.
Degree of probability and provision for liability
Virtually certain: Recognise liability
More than 50%: Make provision
Less than 50%: Disclose contingency liability note
Remote: No disclosure
What are the 3 conditions requiring the recognition of a provision based on IAS 37 ?
(VERY IMPORTANT TO LEARN!)
1) An entity has a present obligation as a result of a past event
2) It is probable that the outflow of resources that carry economic benefits will be required to settle the obligation.
3) A reliable estimate can be made of the amount of the obligation.
What are the 2 types of obligations?
Legal- Arising from a legal event. e.g. contractual agreements.
Constructive- informal commitments or promises made by an organisation that create a sense of responsibility to meet certain obligation.e.g. refund unhappy customers.
Can you use BP’s oil spillage as an example to explain provisions?
When it initially happened, they knew they had to pay fines, but not sure how much. They therefore had to set up provisions and contingency liabilities. Hard to identify an amount as it depended on so many factors. They initially expected to pay $20 bn, but ended up paying $60 bn. This shows how. big the gap between a provision and actual amount can be.
What did the Financial Reporting Council (FRC) review on IAS 37 say?
IAS 37 has frequently been identified as an area of non-compliance.
What did FRC identify as the key problematic areas?
- Provisions of qualitative information
- Uncertanity, estimation and significant judgement
- Numerical disclosures
Explain provisions of qualitative information:
- Absence of historical information- lack of context.
- Disclosures usually vague and obligations poorly described.
Explain uncertainty, estimation and significant judgement:
- Methods of estimation rarely disclosed.
- Derivation of discount rate not clearly explained.
Explain Numerical disclosures:
- Lack of information about timings of outflows
- Information is very sparse, making it hard to make informed decisions.
