CPA PROGRAM

STUDENT SUPPORT SLIDES 2015

FINANCIAL REPORTING
MODULE 3: PROVISIONS, CONTINGENT LIABILITIES AND
CONTINGENT ASSETS

PROVISIONS
Provision = liability of uncertain timing or amount

Recognition criteria (IAS 37, para. 14) :

1.

Present obligation as result of past event.

2.

Probable outflow of resources.

3.

Reliable estimate can be made.

PROVISIONS: RECOGNITION CRITERIA (1)

Present obligation

Legal obligation

Constructive obligation

Derives from:

Derives from:

A contract

Legislation

Established pattern of
past practice

Other operation of law

Creation of valid
expectation

PROVISIONS: RECOGNITION CRITERIA (2)

Example: constructive obligation (see definition IAS 37, para. 10)
An entity in the oil industry causes contamination and operates in a country where there
is no substantial environmental legislation. However, the entity has a widely published
environmental policy in which it undertakes to clean up all contamination that it causes.
The entity has a record of honouring this policy.

The obligating event is the contamination of the land which gives rise to a constructive
obligation because the past conduct of the entity has created a valid expectation on the
part of those affected by it that the entity will clean up contamination.

PROVISIONS: RECOGNITION CRITERIA (3)

Probable outflow of resources

Regarded as probable when more likely than not (> 50% likely) (IAS 37,
para. 23)
May be assessed by considering class of obligations as a whole
e.g. product warranties (IAS 37, para. 24)

PROVISIONS: RECOGNITION CRITERIA (4)

Reliable estimate can be made

Use of estimate does not undermine reliability (a number of possible outcomes
may exist) (IAS 37, para. 25)
If reliable estimate cannot be made liability cannot be recognised (disclosed as a
contingent liability) (IAS 37, para. 26)

PROVISIONS: MEASUREMENT (1)

The amount recognised as a provision should be the best estimate of the expenditure
required to settle the obligation at the end of the reporting period (IAS 37, para. 36).

Where there is a large population of items, the obligation is estimated by weighting all
possible outcomes by their associated probabilities (expected value) (IAS 37, para. 39).

Where a single obligation is being measured, the individual most likely outcome
may be the best estimate of the liability (IAS 37, para. 40).

Risks and uncertainties should be taken into account (IAS 37, para. 42).

Where the effect of the time value of money is material, the amount of a provision
should be the present value of the expenditures expected to be required to settle the
obligation (IAS 37, para. 45).

The discount rate(s) should be a pre-tax rate (or rates) that reflect current market
assessments of the time value of money and the risks specific to that liability (IAS 37,
para. 47).

PROVISIONS: MEASUREMENT (2)

Example: expected value
A Ltd sells 10 000 goods with a one-year warranty which allows them to be returned for
repair. If minor repairs are required on all of the goods the total cost would be $200 000.
If all items required major repairs the total cost would be $1 000 000.

A Ltd estimates that:

Provision for repairs:

75% of the goods will not be returned

20% will be returned with minor defects

20% 200 000 = $40 000

5% will require major repairs

5% 1 000 000 = $50 000

$90 000

SPECIFIC APPLICATIONS (1)

Restructuring (provision)
1. Other than as part of an acquisition
Only recognised when the entity (IAS 37, para. 72)
has a detailed formal plan, and
has raised a valid expectation by starting to implement the plan or
announcing its main features

2. Recognised as part of an acquisition (IFRS 3, paras 10 and 11)

only recognised when the acquiree has an obligation to restructure
costs the acquirer expects (but is not obliged) to incur in future (e.g.
redundancy, relocation) should be treated as post-acquisition expenses

SPECIFIC APPLICATIONS (2)

Future operating losses (IAS 37, para. 63)

do not provide
Onerous contracts (IAS 37, para. 66)
recognise the present obligation

Dividends (IAS 10, paras 12 and 13)

do not provide unless authorised before reporting period end

Decommissioning costs
provide when asset acquired if the obligation is incurred when the asset is
acquired
Changes in decommissioning provision (IFRIC 1):
cost model: capitalise as part of cost
revaluation model: recognise in OCI

10

CONTINGENT LIABILITIES AND ASSETS (1)

Contingent asset (IAS37, para.10)
A possible asset that arises from
past events and whose existence
will be confirmed by the
occurrence of one or more
uncertain future events not wholly
within the entitys control.

11

Disclose where inflow of economic

benefits is probable (IAS37, para. 34).
Where virtually certain recognise asset
(no longer contingent) (IAS37,
para. 33).
Where possible/remote ignore.

Contingent liability (IAS37,

para.10)
A possible obligation that arises
from past events and whose
existence will be confirmed by
the occurrence of one or more
uncertain future events not
wholly within the entitys control;
or
A present obligation where an
outflow is not probable or cannot
be measured reliably.

Next slide

CONTINGENT LIABILITIES AND ASSETS (2)

Start

Present
obligation?

Contingent liabilities
No

No

Yes

Yes
Probable
outflow?

Possible
obligation?

No

Yes
Remote?

Yes
No
Reliable
estimate?

No

Yes
Provide
as a liability

12

Disclose
contingent liability

Do nothing