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NAS 37 Provision, Contingent Asset and Contingent Liabilities
NAS 37 Provision, Contingent Asset and Contingent Liabilities
Revision Note
Relevant For CAP-II students
Unit Overview
NAS 37
Recognition
Provision Contingency
Contingent
Asset
Contingent
Liability
Relevant Definition
1. Provision:
Provision is liability of uncertain timing or amount.
2. Obligation:
It is something that cannot be avoided:
a. Constructive obligation: Arises from an entity’s established pattern of past
practice, published polices or sufficiently specific current statement, that
indicate to other parties that it will accept certain responsibilities and, as a
result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities.
b. Legal obligation: Arises from a contract or from laws and legislation.
Obligation
Legal Constructive
Contract( through
Based on past
explicit or implicit
practice
terms)
Legislation Commitment
Other operation
of law
3. Contingent Liabilities:
It is:
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 the 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 (more than 10%))
because it is not possible to make a reliable estimate of the obligation.
4. Contingent Assets:
It 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.
Recognition
1. Provision:
P robable that
Present As a outflow of Rel iable
obligation(le result of res ourc es will es timate Provision
gal or past be required to ca n be ma de
constructive) event s ettle the
obligation
ma de
2. Contingent liabilities:
i.e.
Remote= ignore
Possible= ignore
Probable= disclose
Note:
a. Probable: more than 50% likely.
b. Possible: Less than 50% likely.
c. Remote: less than 5% probable
d. Virtually certain: more than 95% probable
Alpha Ltd. has entered into a sale contract of Rs. 7 crores with Gamma Ltd. during 2072-73
financial years. The profit on this transaction is Rs. 1 crore. The delivery of goods to take place
during the first month of 2073-74 financial years. In case of failure of Alpha Ltd. to deliver
within the schedule, a compensation of Rs. 2 crores is to be paid to Gamma Ltd. Alpha Ltd.
planned to manufacture the goods during the last month of 2072-73 financial year. As on the
reporting date (31.3.2073), the goods were not manufactured and it was unlikely that Alpha
Ltd. will be in a position to meet the contractual obligation. You are required to advise Alpha
Ltd. on requirement of provision for contingency in the financial statements for the year ended
31st Ashadh, 2073, in line with provisions of Accounting Standards? (June 2017) (5 marks)
Answer:
As per NAS 37, Provision shall be recognized when and only when:
An entity has present obligation (legal or constructive) as a result of a past event.
It is probable (more than 50% likely) that an outflow of resources embodying
economic benefits will be required to settle the obligation.
A reliable estimate can be made of amount of obligation.
If this conditions are not met, no provision should be recognized.
In the given case, Alpha Ltd. has present obligation to deliver the goods as a result of contract
entered with the customer and it is more likely than not that Alpha Ltd. will be required to
settle the obligation on account of penalties. Therefore, Alpha Ltd. should provide for the
provision amounting Rs. 2 crores as per NAS 37.
M/s Dalima Ltd. is in a dispute with the competitor company. The dispute is regarding the
alleged infringement of copyrights. The competitor has filed a suit in the court seeking
damages of Rs. 325 lakhs.
Directors are of the view that the claim can be successfully resisted by the company.
How the matter be dealt in the financial statements of the company in the light of NAS
37. Explain in brief giving reasons for your answer. (CAP Jun. 2018 Q5b-5 Marks)
Answer:
As per NAS 37, Provision shall be recognized when and only when:
An entity has present obligation (legal or constructive) as a result of a past event.
It is probable (more than 50% likely) that an outflow of resources embodying
economic benefits will be required to settle the obligation.
A reliable estimate can be made of amount of obligation.
If this conditions are not met, no provision should be recognized.
In the given situation, since the directors of the company are of the opinion that the claim
can be successfully resisted by the company, therefore there will be no outflow of
resources. Hence no provision is required. The company can disclose the same as
contingent liability by way of following note.
Compiled by CA. Prasant Tamang
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NAS 37 Provisions, Contingent Liabilities, and Contingent Assets
Revision Note
Relevant For CAP-II students
Litigation is in the process against the company relating to dispute with the competitor
who alleged that the company has infringed copyrights and seeking damages of Rs. 325
lakhs. However the director are of the opinion that the claim can be successfully resisted
by the company.
Additional Notes:
Specific Situation
It is a contract in which the unavoidable costs of meeting the contract exceed the
economic benefits expected to be received under it.
A common example of an onerous contract is a lease on a surplus factory. The
leaseholder signed a lease agreement in the past that has legally obliged them to
carry on paying the rent on the factory. However, no benefits will be obtained from
using the factory.
If an entity has an onerous contract, a provision should be recognized for the present
obligation under the contract.
The provision is measured at the least net cost:
lower of cost of fulfilling the contract or
terminating it and suffering any penalty payments.
3. Future repairs to assets:
Some assets need to be repaired or to have parts replaced every few years. For
example, an airline may be required by law to overhaul all its aircraft every 3
years.
Provisions cannot normally be recognized for the cost of of future repairs or
replacement parts.
Even if the future expenditure is required by law, the entity could sell the assets
and avoid the expense.
Instead, the expenditure should be capitalized when incurred and depreciated over
its useful life.