IAS 37 provisions, contingent liabilities & assets

1. FINANCIAL ACCOUNTING
IAS 37: PROVISIONS , CONTINGENT LIABILITIES &
ASSETS
GROUP MEMBERS:
GROUP LEADER : AIMAL SHAHBAZ BALOCH
FAKHIR ALI
KIRAN SHEHZADI
SIDRA MUGHAL

2. Asset Side
Inflow is virtually
certain
More than 95%
Pass journal
entry
Record the asset
Inflow is
probable
50-95%
Disclose the
contingent asset
Inflow is possible
or remote
5-50%
Do nothing
Examples of Virtually Certain:
 Insurance company agreed to pay
 Our suppliers agreed to pay damages

3. Liability Side
Contingent liability
Possible obligation it will be
confirmed by a future event
or not in the control of the
entity
Present obligation due to
past event
Probable outflow
No reliable estimate
Do nothing
Provision
Present obligation due to
past event
Probable outflow
Reliable estimate
Outflow
is remote

4. PROVISION:
An
obligation that is
known to exist,
although the
obligee may not
be known, and
the amount and
timing of
payment is
subject to
uncertainty.
Provision for
warranty
•Provision for
dismantling
•Provision for
restructuring
1. Present
obligation
is a result
of past
event
2. There is
probable
outflow
of
resources
3. Reliable
estimate
can be
made
Obligation
Legal
Constructive ( through entity’s actions which created valid expectation
in mind of other parties

5. PROVISION IS A LIABILITY
An obligation
always involves
another party to
whom the
obligation is
owed. However, it
is not necessary
to know the
identity of that
party. It is
perfectly possible
to have an
obligation to the
public at large or
to a group of
people
The
estimates of
the outcome
and financial
effect of an
obligation
are made by
independent
experts.
Only
obligations
arising from
past events
that exist
independentl
y of a
company's
future actions
are
recognised as
provisions.

6. • Example#1:
Kiran corporations gives warranties at the time of sale to purchase of its
products . Under the terms of the sale contract of the company the company
undertakes or in its policy to make good any manufacturing defects that
become apparent within 3 years from date of sale .
in this period it has sold 250000 appliances and estimates that about 2% will
prove faulty.
• Answer:
• There is an obligatory event being the sale of item with the promise to
repair it as necessary . The fact that kiran corporation does not know which of
its customers will seek repairs in the future Is irrelevant to the existence of the
obligation.
• a provision would be recognized for the future repairs.

7. 1.Best Estimate ( using expected
values )
1.Future Events ( these are
considered for measurement )
1.Expected Disposals of Asset ( it is
not considered for measurement )
Reimbursement
Present Value Calculation
M
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1. Reimbursement
 virtually certain ( record journal entry )
 probable ( disclose )
 possible or remote ( do nothing)

8. When there is a large population of potential
obligations .
For those estimated liabilities consisting of only a few (or a single) discrete
obligations, the most likely outcome may be used to measure the liability
when there is a range of outcomes having roughly similar probabilities;
but if possible outcomes include amounts much greater (and lesser) than the
most likely, it may be necessary to accrue a larger amount if there is a significant
chance that the larger obligation will have to be settled
Expected value :
which is operationally defined as the amount the enterprise
would pay, currently, to either settle the actual obligation or provide
consideration to a third party to assume it.
WHEN
Discrete
greater
than the
most
likely

9. EXMPLE#2: A company offers goods for sale with a 6 months warranty , where
goods sold that are found to be faulty within 6 months after purchase may be returned
for a full refund . Not all goods will be faulty and similarly not all customers bother to
return faulty goods . The company past experience suggests that the following are the
possible outcomes and the probability thereof
Calculate Expected cost of provision and journalize it
Answer: the provision measured as the expected value of the future cost of
fulfilling the warranty obligation , that is calculated as fellow as
Expected value= 70% * 0 + 30% * 100,000 = 30,000
Journal entry
warranty cost 30,000
provision for warranty cost 30,000
outcomes probability Estimated cost
Goods will not be
returned
70% 0
Gods will be
returned
30% 100,000
100%

10. The "risks and uncertainties"
surrounding events and
circumstances should be taken into
account in arriving at the best
estimate of a provision
‘Uncertainty’ should not justify
the creation of excessive
provisions or a deliberate
overstatement of liabilities
Future Events
Example # 3
A company owns a number of nuclear plants .the company is presently obliged to dismantle
one of these nuclear plants in 3 years .
The last nuclear plant dismantled by the company cost Rs. 1,ooo,ooo to dismantle but the
company expects to dismantle this nuclear plant , is using the same technology , at a slightly
reduced cost of Rs. 800,000 due to the increased experience . There is however a chance that
completely new technology may be available at the same time of dismantling , which could
lead to a further Rs. 200, 000 cost saving.
Discuss the measurement of provision

11. Answer:
A provision should reflect expected future events where there is
sufficient objective evidence that these will occur . Since the company
he had experience in dismantling plants , it is argued that the expected
cost saving through this experience is reasonably expected to occur. The
cost savings expected as a result of the possible introduction of
completely new technology , are outside the control of company , should
not be considered , unless of course the company has sufficient
objective evidence that this technology will be available . The provision
should be measured at Rs. 800,000.

12. Example 4 :
new legislation means that fakhir ltd. Must dismantle its nuclear
pant in a year’s time . The dismantling is estimated to cost Rs. 300,000
but company expects to earn income from the sale of scrap metal of
Rs. 100,000. the effects of discounting are expected to be immaterial.
Process the journal entry to raise the provision.
Answer:
PARTICULARS Dr. Cr.
Nuclear plant 300,000
Provision of dismantling
cost
300,000
Gain on disposal:
Gains from expected disposal of assets should not be taken into account
in arriving at the amount of the provision (even if the expected disposal
is closely linked to the event giving rise to the provision).

13. Reimbursements by other parties
should be taken into account when
computing the provision, only if it is
virtually certain that the
reimbursement will be received.
The reimbursement should be
treated as a separate asset on
the balance sheet.
However, in the income
statement, the provision may be
presented net of the amount
recognized as a reimbursement
R
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14. PARTICULARS Dr. Cr.
Guarantee expense 100,000
Provision for Guarantee 100,000
Receivable 100,000
guarantee reimbursement
income
100,000
The journal entry will be the same because the reimbursement asset is not allowed to
be measured at more than the provision.
Example #5 : A retailer company estimates that it will cost Rs. 100,000 to fulfill its
obligation in respect of the guarantee offered to its customers . The manufacturer ,
however , offers a guarantee to the retailer company.
Show all related journal entries
Entire Rs. 100, 000 is virtually certain of being received from the manufacturer.
An amount of Rs. 120,000 is virtually certain of being received from the manufacturer.

15. WHEN
• Where the effect of the time value of money is material, a
provision is measured at the present value of the expenditures
expected to be required to settle the obligation.
RATE
• The discount rate used should be a pre-tax rate (or rates) that
reflect(s) current market assessments of the time value of
money and the risks specific to the liability.
Present value calculation / Time value
Example # 6
Gujrat Prefabricators Limited (GPL) has won a contract to provide temporary accommodation
for workers involved in building a new airport. The contract involves the erection of
accommodation blocks on a public park and two years later the removal of the blocks and
the reinstatement of the site. The blocks have been built and it is now 31 December 2015
(GPL’s year-end). GPL estimates that in two years it will have to pay Rs. 2,000,000 to remove
the blocks and reinstate the site. The pre-tax discount rate that reflects currentmarket
assessments of the time value of money and the risks specific to theliability is 10%. The
provision that should be recognised at 31 December 2015 is as follows:
Rs. 2,000,000* 1/(1.1)² ⁼ 1,652,893

16. In most cases the debit entry that arises when a
provision is recognised is an expense. There is one
important case where it is capitalised as an asset.
PARTICULARS Dr. Cr.
Profit or loss
(expense)
X
Provision X
A provision is set up to recognise an expense (usually) that
exists at the reporting date. When the expense is paid the
following double entry is used:
PARTICULARS Dr. Cr.
Provision X
Cash X
RECOGNITION

17. Subsequent re-measurement of provisions.
PARTICUARS Dr. Cr.
Derecognition of a provision that is no longer needed.
Provision X
Income statement X
Increase in a provision:
Profit or loss (expense) X
Provision X
Decrease in a provision:
Provision X
Profit or loss X

18. During the
year
•Opening & closing balances
•movements in the
provision
 Brief
description
of
the nature of the obligation;
•the expected timing of any
settlement;
an indication of the
uncertainties surrounding
the amount and timing of
any settlement.

19. Onerous Contract
an onerous contract is one where the unavoidable costs of meeting
the obligation under the contract exceed the benefits expected to
be derived from the contract.
A provision should be made for the additional unavoidable costs of an onerous contract.
for the unavoidable costs are
the lower of
the cost of fulfilling
the contract
the compensation or penalties
that paid if the contract were to
be canceled.

20. • Example # 7:
Ammad ltd. Entered into a contract to perform certain
services.
The total contract price id Rs. 80,000
The estimated costs of fulfilling these contractual obligation
have been recently re assessed to be Rs. 140,000. no work
has yet been done.
A penalty of Rs. 30,000 is payable if the contract is to be
cancelled.
Journal entry is required
• Answer:
Contract cost expense 30,000
provision for onerous contract 30,000
• Where the expected loss is 60,000 ( 140,000 – 80,000 )

21. the sale or termination of a line of business
Examples
the closure of business operations in a country or geographical region, or
relocation of operations from one region or country to another
major changes in management structure, such as the removal of an entire ‘layer’
of management from the management hierarchy
fundamental reorganizations changing the nature and focus of the company’s
operations.
has a detailed formal plan for the restructuring
identifying at least:
obligation to
restructure arises
• the business or part of a business concerned;
• the principal locations affected;
• the expenditures that will be undertaken
• when the plan will be implemented;
• the location, function, and approximate number of employees
affected
has raised a valid expectation
expectation
that it would carry out the restructuring by starting to implement that
plan or announcing its main features to those affected by it.
Restructuring

22. • necessarily entailed by the restructuring; and
• not associated with the ongoing activities of
the company.
A restructuring provision
must only include the direct
expenditures arising from the
restructuring. These are
those that are both:
• retraining or relocating continuing staff;
• marketing; or
• investment in new systems etc.
A restructuring provision
would not include costs that
are associated with ongoing
activities such as:

23. Example # 8:
A few days year end , Insan lit. Announced its intention to close its shoe factory within 6
months of year end . There is detailed formal plan that lists amongst other things the
costs of closure
• Retrenchment packages Rs. 1,000,000
• Retraining the staff members who will be relocated to other factories Rs. 500,000
• Loss on sale of factory assets Rs. 100,000
• Journal entry is required
Answer:
restructuring cost 1,000,000
provision for restructuring cost 1,000,000

24. Decommissioning liabilities and similar provisions
A company may be required to ‘clean up’ a location where it has been
working when production ceases.
Accounting for a provision for a decommissioning liability:
 IAS 16 Property, plant and equipment identifies the initial estimate of the costs of
dismantling and removing an item and restoring the site upon which it is located as
part of the cost of an asset.
 Future clean-up costs often occur many years in the future so any provision
recognised is usually discounted to its present value.
Journal entry:
Dr. Cr.
Non-current asset X
Provision X

25. Future operating losses:
• A provision shall not be
recognized for future operating
losses
• A company may forecast that it
will make a substantial operating
losses in the next year or years .
Provision can not be made for
operating losses because they arise
from future events and not past
events.

26. Contingent liability :
it is
• present obligation due to
past event
• in which outflow is
probable
• no reliable estimate can
be made
OR
possible obligation ( 5-50 )
from the past event whose
existence will be confirm
only by an uncertain future
event not in the control of
entity.
Treatment: we will
not record provision.
Disclosure is
required.
If there are remote
chances of outflow
no disclosure is
required.
. The event is known
and the effect is
known, but the
amount itself is
uncertain
. depreciation is an
estimate, but not a
contingency,
there will be an
impairment of an asset
or the occurrence of a
liability is the
uncertainty that will be
resolved in the future.

27. EXAMPLE # 9:
CONTINGENT LIABILITY
AT THE YEAR END
CUSTOMER HAVE FILED A CASE
AGAINST FOR SUPPLYING
DEFECTIVE GOODS . IF WE LOSE
THE CASE , THEN WE WILL PAY
OUT RS. 5 MILLION . IF WE WIN
WE WILL PAY NOTHING LAWYER
IS UNSURE THAT WHAT WILL
HAPPEN
ANSWER
• THE RS 5 MILLION IS
A POSSIBLE OBLIGATION
ARISING OUT FROM THE
PAST EVENT . BUT THE
OBLIGAATION WILL ONLY
BE CONFIRMED BY FUTURE
EVENT.
• WE WILL NOT
RECOGNIZE RS. 5 MILLION
. INSTEAD WE WILL
DISCLOSE THE DETAIL OF
COURT CASE AND THE
AMOUNT INVOLVED IN
THE “ NOTES TO THE
FINANCIAL STATEMENT’.

28. Virtually certain asset:
if we are sure that we will receive
any aount in future we will record it
as an asset.
Example # 10
A fire broke out on evening of
december . We suffered a loss of Rs,
60 million on fixed asset and
inventories . In this respect , a fire
insurance claim has been lodged on *
december . The insurance company
agreed on 6 january to pay the
amount.
Answer:
As the insurance claim of Rs, 60
million is virtually certain to be
received ; an insurance claim would
be recognized for this amount.

29. Example # 11 :
on 15 December , we lodged a claim Rs. 8 million against one of our supplier for
supply of inferior quality goods . Our lawyer is saying that there is a probability that we
will win the case.
Answer:
An inflow is probable so we will only disclose.
Contingent asset:
A possible asset that arises from past events 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 reporting enterprise.
if there is probability of inflow of economic benefits a contingent asset is
disclosed .
if inflow is remote or possible no disclosure is required.

30. Disclosures:
for each class of provision disclose the
following
• opening balances
• Additions due to change in estimates
• Provisions used
• Additions due to passage of time
• Unused amount reversed
• Closing balance
For each significant provision
• Brief description of nature
• Indication of uncertainties
• Probability of any reimbursement