FFQA 1

IAS 37
Provisions
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 the financial statements to enable users to understand
their nature, timing and amount. The key principle established by the Standard is that a
provision should be recognised only when there is a liability i.e. a present obligation resulting
from past events. The Standard thus aims to ensure that only genuine obligations are dealt with
in the financial statements - planned future expenditure, even where authorised by the board
of directors or equivalent governing body, is excluded from recognition

Definition of PROVISION
Liability:
• present obligation as a result of past events
• settlement is expected to result in an outflow of resources (payment)

A provision is a liability of uncertain timing or amount.

Recognition
The recognition criteria are the same as those in the Framework for all liabilities:
(i) When an entity has a present obligation (legal or constructive) as a result of a past event;

(ii) It is probable that an outflow of economic resources will be required to settle the obligation, and

(iii) A reliable estimate can be made of the amount of the obligation.

Unless these conditions are met, no provision can be recognised.

Provisions should be reviewed each year and adjusted to reflect current best estimate. If it is
no longer probable that an outflow of resources embodying economic benefits will be
required, the provision should be reversed.

A past event which leads to a present obligation is called an obligating event. For an event
to be an obligating event, it is necessary that the entity has ‘no realistic alternative to settling
that obligation’ created by the event.

A legal obligation is one that derives from a contract, legislation or any other operation of
law. A constructive obligation is an obligation that derives from the actions of an entity
where:
(i) From an established pattern of past practice, published policies or a specific statement the
entity has indicated to other parties that it will accept certain responsibilities; and
(ii) As a result the entity has created a valid expectation in other parties that it will
discharge those responsibilities
Complied by: Mohammad Faizan Farooq Qadri Attari
ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 2
Examples of Provisions
Circumstance Accrue a Provision?
Restructuring by sale of an operation Accrue a provision only after a binding sale agreement

Restructuring by closure or Accrue a provision only after a detailed formal plan is adopted and
reorganisation announced publicly. A Board decision is not enough

Warranty Accrue a provision (past event was the sale of defective Goods)

Land contamination Accrue a provision if the company's policy is to clean up even if there
is no legal requirement to do so (past event is the obligation and
public expectation created by the company's policy)

Customer refunds Accrue if the established policy is to give refunds (past event is the
customer's expectation, at time of purchase, that a refund would be
available)

Offshore oil rig must be removed Accrue a provision when installed, and add to the cost of the asset
and sea bed restored

Abandoned leasehold, four years to Accrue a provision

run

CPA firm must staff training for No provision (there is no obligation to provide the training)
recent changes in tax law

Major overhaul or repairs No provision (no obligation)

Onerous (loss-making) contract Accrue a provision

Measurement
The amount recognised as a provision is the best estimate of the expenditure required to
settle the obligation at the balance sheet date.
Provisions should be discounted where the effect of the time value of money is material.

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 3
Definition of Contingent liability
A contingent liability is either:
(a) A possible obligation arising from past events whose existence will be confirmed
only by the occurrence of one or more uncertain future events not wholly within
the control of the entity; or

(b) A present obligation that arises from past events but is not recognised because:
(i) It is not probable that an outflow of economic benefit will be required to
settle the obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability.

Recognition
An entity should not recognise a contingent liability. A contingent liability is disclosed unless
the possibility of an outflow of economic benefits is remote.

QUESTION FFQA1
(1)Proviso Co issued a 1 year guarantee for faulty workmanship on a single item of specialist
equipment that it delivered to its customer. At the company's year end, the company is
being sued by the customer for refusing to replace or repair the item of equipment within the
guarantee period, as Proviso believes the fault is not covered by the guarantee, but instead
has arisen because of the customer not following the operating instructions.

The company's lawyer has advised Proviso that it is more likely than not that they will be
found liable. This would result in the company being forced to replace or repair the
equipment plus pay court costs and a fine amounting to approximately $10,000.

Based on past experience with similar items of equipment, the company estimates that there
is a 70% chance that the central core would need to be replaced which would cost $40,000
and a 30% chance that the repair would only cost about $15,000.

(2) The company also manufactures small items of equipment which it sells via a retail network.
The company sold 12,000 items of this type this year, which also have a 1 year guarantee if
the equipment fails. Based on past experience, 5% of items sold are returned for repair or
replacement. In each case, one third of the items returned are able to be repaired at a cost
of $50, while the remaining two thirds are scrapped and replaced. The manufacturing cost
of a replacement item is $150.

Required
Discuss the accounting treatment of the above situations.

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 4
Definition of Contingent asset
A contingent asset is a possible asset arising from past events whose existence will only
be confirmed by the occurrence of one or more uncertain future events not wholly within
the control of the entity.

Recognition
An entity should not recognise a contingent asset because it could result in the recognition
of profits that may never be realised. However, where the realisation of profit is virtually
certain, then the related asset is not a contingent asset and recognition is appropriate.

A contingent asset is disclosed where an inflow of economic benefits is probable.

Provisions should not be recognised for future operating losses.

Future operating losses do not meet the definition of a liability or the Framework recognition
criteria.

Onerous contracts
If an entity has a contract that is onerous a provision should be made for the net loss.
IAS 37 defines an onerous contract as one in which unavoidable costs of completing the
contract exceed the benefits expected to be received under it

Lecture e

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 5
QUESTION FFQA2
You have a contract to buy 300 metres of silk from China Co each month for $9 per metre. From
each metre of silk you make one silk shirt. You also incur labour and other direct variable costs
of $8 per shirt.
Usually you can sell each shirt for $20 but in late July 20X8 the market price falls to $14. You are
considering ceasing production since you think that the market may not improve.
If you decide to cancel the silk purchase contract without 2 months' notice you must pay a
cancellation penalty of $1,200 for each of the next two months.
Required
(a) Is there a present obligation at the period end 31 July 20X8?
(b) What will appear in respect of the contract in your financial statements for the period
ending 31 July 20X8?
Restructuring
A provision for restructuring costs is recognised only when the entity has a constructive
obligation to restructure. Such an obligation only arises where an entity:
(i) Has a detailed formal plan for the restructuring, and

(ii) Has raised a valid expectation in those affected that it will carry out the restructuring
by starting to implement the plan or announcing its main features to those affected by
it.

A restructuring provision should include only direct expenditures arising from the
restructuring and which are:
(a) Necessarily entailed by the restructuring; and
(b) Not associated with the ongoing activities of the entity.
A restructuring provision does not include such costs as:
– Retraining or relocating continuing staff;
– Marketing; or
– Investment in new systems and distribution networks.

QUESTION FFQA3L
On 12 December 20X0 the board of an entity decided to close down a division.
Required
(i) Assuming that no steps were taken to implement the decision and the decision was not
communicated to any of those affected by the balance sheet date of 31 December 20X0,
explain the appropriate accounting treatment.

(ii) Explain the appropriate accounting treatment for the closure if a detailed plan had been
agreed by the board on 20 December 20X0, and letters sent to notify customers. The staff of
the division have received redundancy notices.

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 6
Decommissioning and other environmental costs
These provisions should only be recognised from the date on which the obligating event
occurs.

QUESTION FFQA4
An entity operates an offshore oilfield where its licensing agreement requires it to remove the
oil rig at the end of production and restore the seabed. 90% of the eventual costs of this work
relate to the removal of the oil rig and restoration of damage caused by building it, and 10%
through the extraction of oil. At the balance sheet date, the rig has been constructed but no oil
has been extracted.
Required
(i) When do the obligations arise in respect of the two portions of the cost?
(ii) How should these be dealt with in the financial statements?

QUESTION FFQA5
How should a contingent liability be included in a company’s financial statements if the
likelihood of a transfer of economic benefits to settle it is remote?
A Disclosed by note with no provision being made
B No disclosure or provision is required

QUESTION FFQA6
In preparing the financial statements of a company, the following items have to be considered:
1. The company offers a one year warranty to purchasers, undertaking to replace an item if a
defect occurs. Past experience suggests that claims under the warranty will probably arise.

2. The company has an action pending against it for damages for wrongful dismissal of a
director. The company.s legal advisor considers it improbable that the action will be successful.

3. The company has guaranteed the overdraft of a subsidiary. The subsidiary is trading
profitably and the probability of a liability arising is remote.
How should these items be reflected in the financial statements, if at all?
A All three should be disclosed by note.

B A provision should be created for the best estimate of the liability in 1, and items 2 and 3
should be disclosed by note.

C A provision should be created for the best estimate of the liability in 1, item 2 should be
disclosed by note and item 3 not disclosed at all.

D A provision should be created for the best estimate of the liabilities in 1 and 2 and item 3
should be disclosed by note

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 7
QUESTION FFQA7
Which of the following statements about provisions, contingencies and events after the
balance sheet date is/are correct?
1 A company expecting future operating losses should make provision for those losses as soon
as it becomes probable that they will be incurred.

2 Details of all adjusting events after the balance sheet date must be disclosed by note in a
company’s financial statements.

3 Contingent assets must be recognised if it is probable that they will arise.

4 Contingent liabilities must be treated as actual liabilities and provided for if it is probable that
they will arise.
A 4 only B 2 and 4 only C 1 and 2 only
D All four statements are correct

QUESTION FFQA8
Which of the following statements about contingent assets and contingent liabilities are
correct?
1 A contingent asset should be disclosed by note if an inflow of economic benefits is probable.

2 A contingent liability should be disclosed by note if it is probable that a transfer of economic

benefits to settle it will be required, with no provision being made.

3 No disclosure is required for a contingent liability if it is not probable that a transfer of

economic benefits to settle it will be required.

4 No disclosure is required for either a contingent liability or a contingent asset if the likelihood
of a payment or receipt is remote.
A 1 and 4 only B 2 and 3 only C 2, 3 and 4 D 1, 2 and 4

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com
 FFQA 8
QUESTION FFQA9
The following items have to be considered in finalising the financial statements of Q, a limited
liability company:
1 The company gives warranties on its products. The company’s statistics show that about 5%
of sales give rise to a warranty claim.

2 The company has guaranteed the overdraft of another company. The likelihood of a liability
arising under the guarantee is assessed as possible.
What is the correct action to be taken in the financial statements for these items?

QUESTION FFQA10
Which of the following statements about the requirements of IAS 37 Provisions, contingent
liabilities and contingent assets are correct?
1 A contingent asset should be disclosed by note if an inflow of economic benefits is probable.

2 No disclosure of a contingent liability is required if the possibility of a transfer of economic

benefits arising is remote.

3 Contingent assets must not be recognised in financial statements unless an inflow of

economic benefits is virtually certain to arise.
A All three statements are correct B 1 and 2 only C 1 and 3 only D 2 and 3 only

Complied by: Mohammad Faizan Farooq Qadri Attari

ACCA (Finalist)
http://www.ffqacca.co.cc
Contact: faizanacca@yahoo.com