Intermediate Accounting 2019 by Valix: Chapter 4 Provisions and Contingent Liability

1. provisions
CHAPTER4 JudenValencia
JewelMae SAntos

2. Provision
• A provision is an existing contingent liability of uncertain timing or uncertain amount.
• The essence of provision is that there is uncertainty about the timing or amount of the
future expenditure.
• Actually, a provision may be the equivalent of an estimated liability or a loss
contingency that is accrued because it is both probable and measurable.

3. Recognition of provision
a. The entity has a present obligation, legal or constructive, as a result of a past event
b. It is probable that an outflow of resources embodying economic benefits would be required to settle the
obligation
• RANGES OF PROBABILITY
➢ Probable – More than 50%
➢ Possible – 50% or less
➢ Remote – 10% or less
c. The amount of obligation can be measured reliably

4. MEASUREMENTS OF PROVISION
• The amount recognized as a provision should be the best estimate of
the expenditure required to settle the process obligation at the end of
reporting period.
• Where there is a continuous range of possible outcomes and each point
in that range is as likely as any other, the midpoint of the range is
used

5. ILLUSTRATION : expected value method
GIVEN:
6 months after purchase
P 1,000,000 – minor defects repair cost
P 5,000,000 – major defects
75% - goods sold w/ no defects
20% - minor defects
5% - major defects that have been sold
Solution:
75% sales none
20% sales (20% x 1m) 200,000
5% sales (5% x 5m) 250,000
Total expected value 450,000

6. Illustration:
GIVEN:
60% chance the case would not be
dismissed
P 4,000,000 – required to pay
P 2,000,000 – required to pay
30% - chance to pay
70% - chance to pay
10% - risk adjustment factors
Solution:
Weighted probabilities
30% x 4m x 60% 720,000
70% x 2m x 60% 840,000
Expected Cash flow 1,560,000
Risk Adjustment (10% x 1,560,000) 156,000
Estimated amount 1,716,000

7. 1. Risk and uncertainties
2. Present value of obligation
3. Future events
4. Expected disposal of assets
5. Reimbursements
6. Change in provision
7. Use of provision
8. Future operating losses
9. Onerous contract

8. 1. Risks and uncertainties
> The risk and uncertainties that inevitably surround events and circumstances shall be taken into
account in reaching the best estimate of a provision
> As prudence dictates, caution is needed in making judgement under conditions of uncertainty so
that income and assets are not overstated, or expenses and liabilities are not understated.
2. Present value of obligation
> Where the effect of the time value of money is material, the amount of provision shall be the
present value of the expenditure expected to settle the obligation.
> The discount rate should be a pretax rate that reflects the current market assessments of the
time value of money and the risk specific to the liability

9. 3. Future events
> Future events that affect the amount required to settle an obligation shall be reflected
in the amount of provision where there is a sufficient evidence that they will occur
4. Expected disposal of assets
> Gains from expected disposal asset shall not be taken into account in measuring a
provision
5. Reimbursements
>Where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement shall be recognized when it is virtually certain that
reimbursement would be received if the entity settles the obligation

10. 6. Change of provisions
> Provision shall be reviewed at the very end of the reporting period and adjusted to reflect
the current best estimate
7. Use of provisions
> A provision shall be used only for expenditures for which that provision was originally
recognized
8. Future operating losses
>Provision shall not be recognized for future operating losses
>In other words, a provision for operating losses is not recognized because a past event
creating a present obligation has not occurred

11. 9. Onerous Contract
> If an entity has an onerous contract, the present
obligation under the contract shall be recognized and measured as
a provision
> An onerous contract is a contract in which the
unavoidable cost of meeting the obligation under the contract
exceed the economic benefits expected to be received under it

12. RESTRUCTURING
Program that is planned and controlled by management and materially changes either the scope
of the business of an entity or the manner in which that business is concluded
Events that may qualify as restructuring include
a. Sale or termination of the line of business
b. Closure of business location
c. Changes in management structure
d. Fundamental reorganization

13. Provision of Restructuring
A constructive obligation for restructuring arises when two conditions are present
1. The entity has a detailed formal plan for the restructuring
2. The entity has raised valid expectation in the minds of those affected that the
entity will carry out the restructuring by starting to implement the plan and
announcing the main features to those affected by it

14. Amount of Restructuring Provision
> Include only direct expenditure
PAS 37, paragraph 81, specifically excludes the ffg expenditure from the
restructuring provision:
a. Cost of retraining or relocating continuing staff
b. Marketing or advertising program to promote the new company image
c. Investment in new system and distribution network

15. (PAS 37, par 10, defines a contingent liability in two ways)
> A contingent liability is possible obligation that arises from a past event and
whose existence will be confirmed only by the occurrence or nonoccurrence of one or
more certain future events not wholly within the control of the entity
> A contingent liability is a present obligation that arises from past event but is
not recognized because it is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation or the amount of the obligation
cannot be measured reliably

16. Treatment of Contingent Liability
(A contingent liability shall not be recognized in the FS but shall be disclosed only)
The required disclosure are:
a. Brief description of the nature of the contingent liability
b. An estimate of its financial effects
c. An indication of uncertainties that exist
d. Possibility of any reimbursement

17. Contingent asset
PAS 37, par 10, provides the following definition:
• A contingent asset is a possible asset that arises from part event and whose existence will be
confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not
wholly within the control of the entity
• A contingent asset shall not be recognized because this may result to recognition of income that
may never be realized
• A contingent asset is only disclosed when it is probable
• If a contingent asset is only possible or remote, no disclosure is required.

18. Decommissioning liability
> is a obligation to dismantle, remove, and restore an item of property, plant and equipment
as required by law or contract
i l l u s t r a t i o n
An entity extracts natural gas and oil in Philippines Deep
On January 1, 2020, the entity constructed a drilling platform for P25,000,000 and is required by
Philippine law to remove and dismantle the platform at the end of its useful life of 10 years
The straight line method is used in depreciating the drilling platform
The entity has estimated that such decommissioning will cost P5,000,000
Based on a 12% discount rate, the present value of 1 for 10 years is 0.322
Thus, the present value of a decommissioning liability is P5,000,000 x 0.322 or P 1, 610,000

19. JOURNAL ENTRY for 2020 & 2021
2020
Jan. 1 Drilling Platform 26,610,000
Cash 25,000,000
Decommissioning Liability 1,610,000
Dec. 31 Depreciation 2,661,000
Accumulated Depreciation (26,610,000/10yrs) 2,661,000
31 Interest Expense 193,200
Decommissioning Liability (12% x 1,610,000) 193,200
2021
Dec. 31 Depreciation 2,661,000
Accumulated Depreciation 2,661,000
31 interest Expense 216,384
Decommissioning Liability) 216,384
Solution:
DL – 01/01/20 1,610,000
IE for 2o2o 193,200
CA –12/31/20 1,803,200
I.E for 2021
(12% x 1,803,200) 216,384

20. Settlement of Decommissioning Liability
On December 31, 2029, after 10 years, the entity contracted with another entity to dismantle and remove
the drilling platform for P 5,500,000
The journal entry to record the settlement of the decommissioning liability is:
Decommissioning Liability 5,000,000
Loss on settlement of decommissioning
Liability 500,000
Cash 5,500,000
On January 1, 2020, the decommissioning liability is P 1, 610,000. this amount plus 12% interest
compounded annually thus build up to P 5,000,000 after 10 years on December 31, 2029

21. Thus, the decommissioning liability is debited at P 5,000,000
The journal entry to derecognize the carrying amount of the drilling platform on December 31, 2029
Accumulated Depreciation 5,000,000
Drilling Platform 5,500,000

22. Change in Decommissioning Liability
Under IFRIC 1, changes in the measurement of an existing decommissioning
liability shall be accounted for as follows:
1. A decrease in the liability is deducted from the cost of the asset
2. An increase in liability is added to the cost at the asset

23. On January 1, 2020, the plant of Sea oil Company is 10 years old. The cost of the plant is
P 12,000,000 with the accumulated depreciation of P 4,000,000.
The plant has a useful life of 30 years and was depreciated using the straight line with no residual
value.
Because of the unwinding discount of 6% over 10 years, the decommissioning liability has grown from P
1,000,000 to P 1,790,000
On January 1, 2020, the discount rate has not change
However the entity has estimated that as a result of technological advances, the net present value of
the decommissioning liability has decreased by P800,000

24. Journal entries for 2020
Jan. 1 Decommissioning liability 800,000
Plant asset 800,000
Dec. 31 Depreciation 360,000
Accumulated Depreciation 360,000
Cost of plant 12,000,000
Reduction of DL ( 800,000)
Net Cost 11,200,000
Accumulated depreciation (4,000,000)
Carrying amount 7,200,000
Depreciation for 2020 (7,200,000/20yrs) 360,000
Given:
P 12,000,000 – cost of plant
P 4,000,000 – accumulated
depreciation
30 years – useful life
6% - unwinding discount
P 1,790,000 – decommissioning
liability
P 800,000 – net present value

25. Cont.
Dec. 31 Interest Expense 59,400
Decommissioning liability 59,400
Decommissioning liability – 01/01/20 1,790,000
Reduction ( 800,000)
Adjusted carrying amount – 01/01/20 990,000
interest expense for 2020 (6% x 990,000) 59,400

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