Even though there is a similar likelihood that Rey Co would win the counterclaim, this is a probably inflow and therefore only a contingent asset can be recorded. At 31 December 20X8, the legal advisors of Rey Co now believe that the $10m payment from the court case would be payable in one year. Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. If it appears that there is a possible outflow then no provision is recorded. The unwinding of this discount would be recorded in the statement of profit or loss as a finance cost. In this case, the provision should be included within the original cost of the asset, as this is directly attributable to the construction of that asset. During 20X8, Rey Co opened a new factory, leading to some environmental damage. 1. The first is to assess whether an obligation exists at the reporting date. If the time value of money is material, generally if the potential outflow is payable in one year or more, the provision should be discounted to present value initially. Rey Co has a cost of capital of 10%. 9. Back to Course Next Lesson. So far, all of the items considered in this article have involved the provision being recorded as a liability with the debit being shown as an expense in the statement of profit or loss. A contingent liability is simply a disclosure note shown in the notes to the accounts. more than 50% likely) that the obligation will result in an outflow of … As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. ... ACCA … Past experience shows that Rey Co needs to do no repairs on 85% of the goods. IFRS 11 Joint Arrangements It can be seen here that Rey Co could only recognise an asset from a potential inflow if it is virtually certain. There is no double entry recorded in respect of this. ... 8:54. Events after the reporting date. Register; Log In; CPD IAS 37 - Provisions, Contingent Liabilities and Assets ... IAS 37 — Provisions, Contingent Liabilities and Assets 4 Steps ondemand_video Determining a Provision 15m 19s playlist_add_check Quiz - Determining a Provision 5 Questions A contingent asset should be disclosed by note if an inflow of economic benefits is probable. In summary, IAS 37 is a key standard for FR candidates. Rey Co gives a year’s warranty with all goods sold during the year. IFRS 3 Business Combinations . ACCA CIMA CPD FIA (ACCA) AAT. Again, a description of the event should be recorded in addition to any potential amount related to this. This relates to a potential inflow of economic resources which could come into the entity. Group accounting – part 1. If the employees have not been informed, then the company could change its mind. Similarly, if Rey Co has to pay to install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8, so no provision is required. In this case, Rey Co would provide $10m, being the most likely outcome. The changes proposed in ED/2018/2 Onerous Contracts — Cost of Ful­fill­ing a Contract (Proposed amend­ments to IAS 37) 1. specify that the ‘cost of ful­fill­ing’ a contract in paragraph 68 of IAS 37 comprises the ‘costs that relate directly to the contract’; and 2. provide examples of costs that do, and do not, relate directly to a contract to provide goods or services. The IASB is likely to wait until the publication of the Conceptual Framework in 2016 before any … IAS 37 full text Outlines the accounting for: (IAS 37 definition) Provisions ; is a liability with uncertain timing or amount. Rey Co could delay the work until 20X9, or sell the building. In this case, Rey Co would include a provision for the $10m loss in liabilities. To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of $3m, with the impact of making the profit seem lower in the current period. Group accounting – part 2. BPP BUSINESS SCHOOL 3 IAS 37 Provisions and contingencies Constructive obligation • Where, by an established pattern of past practice, published policies or a sufficiently specific current statement the entity has indicated to other parties that it will accept certain responsibilities and • As a result, the entity has created a valid expectation that it will discharge those responsibilities IAS 27 Separate Financial Statements. The obligation needs to have arisen from a past event, rather than simply something which may or may not arise in the future. In an exam, it is unlikely that there will not be a reliable estimate. Rey Co has a consistent history of honouring this policy. The final criteria required is that there needs to be a probable outflow of economic resources. C2. Restructuring costs associated with reorganising divisions provide two issues. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. Rey Co has received legal advice that the most likely outcome of the court case from the employee is that they will lose the case and have to pay $10m. Over the useful life of the asset, the $170m will be depreciated. Rey Co’s manufacturing manager has calculated that if minor repairs were needed on all goods it would cost $100,000, and major repairs on all goods would cost $1m. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. Please visit our global website instead, Can't find your location listed? Rey Co estimate that the damage will cost $400,000 to restore. If the employees have not been informed, then the company could change its mind. The exception to this is if an entity creates an obligation for future costs due to the construction of a non-current asset. It will not be uncommon to take the $12m, thinking that the worst-case scenario should be provided for. Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. This quiz is a sample of our larger question bank of 50+ questions on IAS 37. 10. This is effectively an attempt to move $3m profit from the current year into the next period. Here, Rey Co would capitalise the $170m as part of property, plant and equipment. The table below shows the treatment for an entity depending on the likelihood of an item happening. If the employees have been informed, then an obligation exists and a provision must be made. For example, let’s take a fictional company, Rey Co. At the start of the year, Rey Co sets a profit target of $10m for the year ended 31 December 20X8. The definition of a provision is key to the standard. In reality a virtually certain inflow is unlikely. In other words, if there is no past event, then there is no liability and no provision should be recognized. IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. This relates to a potential inflow of economic resources which could come into the entity. Rey Co could not provide for any possible claims which may arise from injuries in the future. ACCA P2 Provisions, contingent assets and liabilities (IAS 37) Free lectures for the ACCA P2 Corporate Reporting Exams This will be disclosed in the notes to the financial statements rather than being recorded as an asset in the statement of financial position. Written by a member of the Financial Reporting examining team, Virtual classroom support for learning partners, IAS 37 – Provisions, contingent liabilities and contingent assets, There needs to be a present obligation from past event. ACCA CIMA CAT DipIFR Search. Free sign up Sign In. IAS 10 Events After The Reporting Period. Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. In this case, the provision should be included within the original cost of the asset, as this is directly attributable to the construction of that asset. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. ACCA CIMA CAT DipIFR Search. Careful attention must also be paid to the calculations involved in the recording of a provision, particularly those around long-term provisions and including them at present value. IAS 33 EPS - Number of shares. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. If the employees have been informed, then an obligation exists and a provision must be made. IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. Likewise it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The chief accountant of Rey Co has reviewed the profit to date and realises they are likely to achieve profits of $13m. This article will consider the aims of the standard, followed by the key specific criteria which must be met for a provision to be recognised. IAS 37 Provisions Contingent Liabilities and Contingent Assets Overview. Here, the provision would be measured at $60k. Subsequently, the discount on this provision would be unwound over time, to record the provision at the actual amount payable. probable ( >50% ) outflow of resources. In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. Free sign up Sign In. A contingent liability is simply a disclosure note shown in the notes to the accounts. Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. IAS 37 requires a provision be recognised when all of the following apply: an entity has a present obligation (legal or constructive) as a result of a past event. However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery. Rey Co could delay the work until 20X9, or sell the building. Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. 7:18. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce the profit down to $10m. Whilst this seems inconsistent, this demonstrates the asymmetry of prudence, that losses will be recorded earlier than potential gains. This will be disclosed in the notes to the financial statements rather than being recorded as an asset in the statement of financial position. C2. For some ACCA candidates, specific IFRS® standards are more favoured than others. Therefore any provision should only include items such as redundancies and closure costs. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. The global body for professional accountants, Can't find your location/region listed? It will not be uncommon to take the $12m, thinking that the worst-case scenario should be provided for. The global body for professional accountants, Can't find your location/region listed? All subject exam questions. The definition of a provision is key to the standard. In addition to this, the discount on the provision will be unwound and the provision increased each year. Even if the country has no legal regulations forcing Rey Co to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history. IAS 19 Employee Benefits. Rey Co estimate that the damage will cost $400,000 to restore. Rey Co has a consistent history of honouring this policy. You are just about to attempt the quiz about the IAS 37 Provisions and Contingencies. 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 provides guidance in the interpretation of the definition of a liability where, for example, an obligation is not legally enforceable or is conditional on the future actions of the entity. Likewise it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. The expected cost of minor repairs would be $10k (10% of $100k) and the expected costs of major repairs is $50k (5% of $1m). the entity has a present obligation. Rey Co gives a year’s warranty with all goods sold during the year. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce the profit down to $10m. Therefore any provision should only include items such as redundancies and closure costs. As soon as an entity is aware that a contract is onerous, the full loss should be provided for as a liability in the statement of financial position. If the item is made up of a number of items, such as a warranty provision for repairing goods, the expected value should be calculated using the probability of all events happening. IAS 37 – Example (restructuring) – ACCA Financial Reporting (FR) Therefore there cannot be included in the financial statemets. According to IAS 37, 3 criteria are required to be met before a provision can be recognised. To address inconsistencies with other IFRSs. The Board proposes no new re­quire­ments for entities to disclose in­for­ma­tion about onerous contracts. The second type of obligation is one called a constructive obligation. IAS 37 – Measurement (present value) – ACCA Financial Reporting (FR) Please visit our global website instead. For example, let’s take a fictional company, Rey Co. At the start of the year, Rey Co sets a profit target of $10m for the year ended 31 December 20X8. The obligation could be a legal or contractual one, arising from a court case or some kind of contractual arrangement. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. IAS 33 Rights Issue. IFRS 10 Consolidated Financial Statements. IAS 37 – Provisions, contingent liabilities and contingent assets For some ACCA candidates, specific IFRS® standards are more favoured than others. Candidates are required to learn the three key criteria for a provision, as they are likely to have to explain these in an exam. To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of $3m, with the impact of making the profit seem lower in the current period. Standard also deals with reimbursements of provisions by another party, changes in provisions and use of provisions. Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. Written by a member of the Financial Reporting examining team, Virtual classroom support for learning partners, IAS 37 – Provisions, contingent liabilities and contingent assets, There needs to be a present obligation from past event. The second issue consideration is which costs should be included within the provision. He also knows that the profit target will be set at $14m in the next year. Most candidates are able to spot this in exams, identifying the presence of a potential obligation of this type. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. Clearly this is not good for the users of the financial statements, as they would have been manipulated and given a false impression of the performance of the business. There is no specific list of what % likelihood is required for an outflow to be probable. As part of obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at the end of its useful life. Rey Co has a published environmental policy. The legal advisors believe that there is an 80% chance that the counter claim against the manufacturer is likely to succeed, and believe that Rey Co would win $8m. This article will consider the aims of the standard, followed by the key specific criteria which must be met for a provision to be recognised. Careful attention must also be paid to the calculations involved in the recording of a provision, particularly those around long-term provisions and including them at present value. The legal team think there is an 80% chance of this. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. IAS 37 Provisions, Contingent Liabilities and Contingent Assets, excludes from its scope contracts which are executory in nature, and therefore prevents the recognition of a liability. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. In this situation, a contingent liability would be reported. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. The key here is whether the restructuring has been announced to the affected employees. C3. For example, in the case of an insurance claim where Rey Co can show they have cover. During 20X8, Rey Co opened a new factory, leading to some environmental damage. Restructuring costs associated with reorganising divisions provide two issues. Similarly, if Rey Co has to pay to install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8, so no provision is required. 2. The obligation could be a legal or contractual one, arising from a court case or some kind of contractual arrangement. Note: Your answer should briefly set out the nature of financial capital in integrated reports. FREE Courses Blog. In an exam, it is unlikely that there will not be a reliable estimate. C2. During this training session the participants will obtain a comprehensive understanding of the detailed requirements of these standards. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. The accountant knows that if Rey Co  reports a profit of $13m, directors will not get any more of a bonus than if they reported $10m. IAS 37 – Provisions, contingent liabilities and contingent assets For some ACCA candidates, specific IFRS® standards are more favoured than others. Rey Co could not provide for any possible claims which may arise from injuries in the future. The second type of obligation is one called a constructive obligation. IAS 37 sets out how to account for the credit risk of the entity IAS 37 does not give any guidance on non-performance risk by the entity In the case of IAS 37, the risk adjustment would measure the amount that it would cost to be free of risk Several existing IFRSs specify the types of costs that should be included in measuring an item. In addition to this, the expected timing of when the event should be resolved should also be included. IAS 37 – provisions and contingent liabilities – ACCA Financial Reporting (FR) This is where IAS 37 is used to ensure that companies report only those provisions that meet certain criteria. If the item is made up of a number of items, such as a warranty provision for repairing goods, the expected value should be calculated using the probability of all events happening. If the time value of money is material, generally if the potential outflow is payable in one year or more, the provision should be discounted to present value initially. In addition to this, the discount on the provision will be unwound and the provision increased each year. These are: These criteria will now be examined in further detail to see how they can be applied in practice. In summary, IAS 37 is a key standard for FR candidates. There is no specific list of what % likelihood is required for an outflow to be probable. Even if the country has no legal regulations forcing Rey Co to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history. This site uses cookies. Rey Co has a cost of capital of 10%. Which of the following statements about the requirements of IAS 37 Provisions, contingent liabilities and contingent assets are correct? Subsequently, the discount on this provision would be unwound over time, to record the provision at the actual amount payable. As soon as an entity is aware that a contract is onerous, the full loss should be provided for as a liability in the statement of financial position. On average, 10% need minor repairs, and 5% need major repairs. Finally, it will examine some specific issues which are often assessed in relation to the standard. The key here is whether the restructuring has been announced to the affected employees. C3. IAS 33 Bonus issue. Similar to the concept of a contingent liability is the concept of a contingent asset. For some ACCA candidates, specific IFRS® standards are more favoured than others. That is because there is no past event which has created the obligation. To understand provisions better, let’s break down the definition of a liability in IAS 37: A liability is a present obligation arising from past event that is expected to be settled by an outflow of economic benefits from an entity. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. This is where a company establishes an expectation through an established course of past practice. These costsshould exclude any costs associated with any continuing activities. Other candidates may calculate an expected value based on the various probabilities. If it appears that there is a possible outflow then no provision is recorded. Then in the next year, the chief accountant could reverse this provision, by debiting the liability and crediting the profit or loss. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. He also knows that the profit target will be set at $14m in the next year. According to IAS 37, 3 criteria are required to be met before a provision can be recognised. IAS 37 requires an entity to record an obligation as a liability only if it is probable (i.e. 6:22. However, IAS 37 is often a key standard in FR exams, and candidates must be prepared to wrestle with applying the criteria. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want. The accountant knows that if Rey Co  reports a profit of $13m, directors will not get any more of a bonus than if they reported $10m. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount. This e-learning course is part of an e-learning series designed by PwC Academy Hungary which aims to provide a comprehensive overview of the application of IFRS (IAS) standards to finance and accounting experts who are already familiar with fundamental (local) accounting and reporting processes. Comments on the proposed changes are re… Similar to the concept of a contingent liability is the concept of a contingent asset. This is because the event arose in 20X8 which could lead to an obligation. Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. 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