Provisions, Cont Liabilities Cont Assets

Front 1

What is a Provision?

Back 1

A provision is a liability of uncertain timing or amount.

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Front 2

When should we recognise a Provision in the books?

Back 2

A provision should be recognised when:

1. An entity has a present obligation (legal or constructive) as a result of a past event,

2. a reliable estimate can be made of the amount of the obligation, and

3. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.

Front 3

What is considered a legal obligation?

Back 3

A legal obligation arises from a contract or from laws and legislation.

Front 4

What is considered a constructive obligation?

Back 4

A constructive obligation arises from an entity's established pattern of past practice or published policies.

As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

Front 5

What does the term probable suggest?

Back 5

An outflow of economic benefits is regarded as probable if it is more likely than not to occur.

Front 6

How much should we recognise a provision at in the financial statements?

Back 6

The amount recognised as a provision should be the best estimate of the expenditure required to settle the obligation that existed at the reporting date.

Front 7

How do you determine the best estimate for a provision?

Back 7

1. The most likely amount payable for a single obligation (such as a court case, environmental clean up or restructuring) or one-off events.

2. An expected value for a large population of items (such as a warranty provision or customer refunds)

3. An entity should use its own judgement in deriving the best estimate,supplemented by past experience and the advice of experts (such as lawyers)

Front 8

Should we discount the provision to reflect the time value of money?

Back 8

YES! but only if the time value of money is material.

The discount rate should be pre-tax and risk specific.

Front 9

What is a Contingent Liability?

Back 9

A possible obligation that arises from past events and whose existence will be confirmed only by the outcome of one or more uncertain future events not wholly within the control of the entity.

A present obligation that arises from past events, but does not meet the criteria for recognition as a provision. This is either because an outflow of economic benefits is not probable or (more rarely) because it is not possible to make a reliable estimate of the obligation.

Front 10

Are Contingent Liabilities recognised?

Back 10

NO! A contingent liability should not be recognised. However, it should bed is closed unless the possibility of a future outflow of economic benefits is remote.

Front 11

What is a Contingent Asset?

Back 11

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the outcome of one or more uncertain future events, not wholly within the control of the entity.

Front 12

Are Contingent Assets recognised?

Back 12

A contingent asset should not be recognised.

A contingent asset should be disclosed if the future inflow of economic benefits is probable.

If the future inflow of benefits is virtually certain, then it ceases to be a contingent asset and should be recognised as a normal asset.

Front 13

Specific Situations: Future Operating Losses

Back 13

No provision should be made for future operating losses

They relate to future, rather than past, events.

The loss ­making business could be closed and the losses avoided,meaning that there is no obligation to make the losses.

An Impairment review under IAS 36 may need to be conducted.

Front 14

Specific Situations: The Onerous Contracts

Back 14

An onerous contract is a contract in which the unavoidable costs of meeting the contract exceed the economic benefits expected to be received under it.

If an entity has an onerous contract, a provision should be recognised for the present obligation under the contract.

The provision is measured at the least net cost: the lower of the cost of fulfilling the contract or of terminating it and suffering any penalty payments.

Front 15

Specific Situations: Future repairs to Assets

Back 15

Provisions cannot normally be recognised for the cost of future repairs or replacement parts.

Instead, the expenditure should be capitalised when incurred and depreciated over its useful life.

Front 16

What are Environmental Provisions?

Back 16

Environmental provisions are often referred to as clean up costs because they usually relate to the cost of decontaminating and restoring an industrial site after production has ceased.

Front 17

When should you recognise Environmental Provisions?

Back 17

A provision is recognised if a past event has created an obligation to repair environmental damage:

The full cost of an environmental provision should be recognised as soon as the obligation arises.

A provision can only be set up to rectify environmental damage that has already happened. There is no obligation to restore future environmental damage because the entity could cease its operations.

Front 18

Should you discount an Environmental Provision?

Back 18

The effect of the time value of money is usually material. Therefore,an environmental provision is normally discounted to its present value.

Front 19

How to account for Provisions in the FS?

Back 19

1. Recognition:

DR. P/L EXPENSE

CR. LIABILITY (Provision)

2. Unwinding the Discount

DR. FINANCE COSTS (P/L)

CR. LIABILITY

3. Use of Provision

DR. LIABILITY

CR. CASH

4. Reimbursement

Front 20

What is Restructuring?

Back 20

Restructuring is a plan of management to change the scope of business or a manner of conducting a business.

Front 21

Give examples of a Restructuring?

Back 21

1. Sale or termination of a line of business

2. the closure of business locations in a country or region or the relocation of business activities from one country or region to another.

3. Changes in management structure, for example, eliminating a layer of management• fundamental reorganisations that have a material effect on the nature and focus of the entity’s operations.

Front 22

When can a restructuring provision be recognised?

Back 22

A restructuring provision can only be recognised where an entity has a constructive obligation to carry out the restructuring.

A board decision alone does not create a constructive obligation. A constructive obligation exists only if:

1. There is a detailed formal plan for restructuring with relevant information in it (about business, location, employees, time schedule and expenditures)

2. A valid expectation related to restructuring has been raised in the affected parties.

Front 23

What amount should be recorded for a Restructuring Provision?

Back 23

A restructuring provision should only include the direct costs of restructuring. These must be both:

1. Necessarily entailed by the restructuring such as redundancy and lease termination costs.

2. Not associated with the ongoing activities of the entity.

Front 24

What costs should not be included in a Restructuring Provision?

Back 24

The following costs must not be included in a restructuring provision:

1. Retraining or relocating staff

2. Marketing

3. Investment in new systems and distribution networks

4. Future operating losses (unless these arise from an onerous contract)

5. Profits on disposal of assets