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Ch08 tb loftus 3e - textbook solution

Management Accounting (University of New South Wales)

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Testbank
to accompany

Financial reporting

3rd edition
by
Loftus et al.

Not for distribution. Instructors may assign selected questions in their LMS.

© John Wiley & Sons Australia, Ltd 2020

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Testbank to accompany Financial reporting 3e by Loftus et al.

Chapter 8: Provisions, contingent liabilities and contingent

assets
Multiple choice questions

1. Which of the following is an example of a provision falling within the scope of AASB 137?

a. Accruals.
*b. Onerous contracts.
c. Insurance contracts.
d. Employee benefits.

Answer: b
Learning objective 8.1: describe the purpose of AASB 137/IAS 37.

2. AASB 137 prescribes the accounting and disclosure for all provisions, contingent liabilities
and contingent assets except for:

a. those arising for insurance entities from contracts with policyholders.

b. those relating to employee benefits.
c. those relating to leases.
*d. none. All of these are exceptions to AASB 137.

Answer: d
Learning objective 8.1: describe the purpose of AASB 137/IAS 37.

3. An example of where an entity has a present obligation is:

*a. a public announcement made by an entity’s management to undertake restructuring.

b. a recommendation from the HR manager to the Board of Directors as to the level of
bonuses to be paid at the end of the financial period.
c. a historical pattern of performing a major overhaul of plant and machinery every three
years.
d. the declaration of a dividend by directors which is yet to be approved at a meeting of
shareholders.

Answer: a
Learning objective 8.2: outline the concept of a provision and how it is distinguished from other
liabilities.

© John Wiley and Sons Australia, Ltd 2020 8.1

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Chapter 8: Provisions, contingent liabilities and contingent assets

Not for distribution in full. Instructors may assign selected questions in their LMS.

4. Which of the following statements is correct?

a. A constructive obligation is an example of an equitable obligation.

*b. An equitable obligation is an example of a present obligation.
c. A present obligation is an example of a legal obligation.
d. A legal obligation is an example of a constructive obligation

Answer: b
Learning objective 8.2: outline the concept of a provision and how it is distinguished from other
liabilities.

5. Which of the following statements is correct?

a. A contingent liability is a class of liabilities.

b. A provision is a class of contingent liabilities.
*c. A provision is a class of liabilities.
d. Contingent liabilities and provisions are classes of liabilities.

Answer: c
Learning objective 8.2: outline the concept of a provision and how it is distinguished from other
liabilities.

6. The uncertainty that exists in relation to provisions is one of:

a. timing.
b. amount.
*c. timing or amount.
d. timing and amount.

Answer: c
Learning objective 8.2: outline the concept of a provision and how it is distinguished from other
liabilities.

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Testbank to accompany Financial reporting 3e by Loftus et al.

7. An event that gives rise to a present obligation, but which cannot be measured with sufficient
reliability is an example of a:

a. accrual.
b. provision.
c. liability.
*d. contingent liability.

Answer: d
Learning objective 8.3: outline the concept of a contingent liability and how it is distinguished
from other liabilities.

8. A contingent liability is defined as a:

I II III IV
possible obligation that arises from past events. Yes Yes No No
possible obligation whose existence will be confirmed Yes No Yes No
by the occurrence of an uncertain future event.
present obligation not recognised because the outflow Yes No Yes No
of economic benefits to settle the obligation is not
probable.
present obligation that is measured reliably. No No Yes Yes

*a. I.
b. II.
c. III.
d. IV.

Answer: a
Learning objective 8.3: outline the concept of a contingent liability and how it is distinguished
from other liabilities.

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Chapter 8: Provisions, contingent liabilities and contingent assets

Not for distribution in full. Instructors may assign selected questions in their LMS.

9. Contingent liabilities are:

a. recognised in the financial statements unless the possibility of an outflow in settlement is

remote.
b. recognised in the notes to the financial statements because the possibility of an outflow in
settlement is remote.
*c. recognised in the notes to the financial statements unless the possibility of an outflow in
settlement is remote.
d. not recognised in the notes to the financial statements because the possibility of an outflow
in settlement is remote.

Answer: c
Learning objective 8.3: outline the concept of a contingent liability and how it is distinguished
from other liabilities.

10. AASB 137 requires provisions to be recognised when:

I there has been a past event.

II an entity has a present obligation.
III the amount of the obligation can be reliably estimated.
IV it is possible that an outflow of resources will be required to settle the obligation.

*a. I, II and III.

b. II, III and IV.
c. I, III and IV.
d. I, II and IV.

Answer: a
Learning objective 8.4: explain when a provision should be recognised.

11. Liabilities which do not meet the recognition criteria and where the possibility of an outflow
of economic resources is remote should:

a. be recognised as an accrual.
b. be recognised as a provision.
c. be recognised as a contingent liability.
*d. not be recognised in the financial statement at all.

Answer: d
Learning objective 8.4: explain when a provision should be recognised.

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Testbank to accompany Financial reporting 3e by Loftus et al.

12. Collins Limited estimated the future cash outflows over the next three years relating to
settlement of warranty obligations would be as follows:

1 year from now: $20 000

2 years from now: $38 000
3 years from now: $45 000

Collins Limited calculates that the present value of the total expected future cash outflow, using a
discount rate of 8%, is:

*a. $ 86 820
b. $ 88 301
c. $ 95 370
d. $103 000

Answer: a
Learning objective 8.5: explain how a provision, once recognised, should be measured.

13. Under AASB 137 Provisions, Contingent Liabilities and Contingent Assets, when providing
for a future event such as the clean-up of a construction site at the end of a long-term project,
gains and other cash inflows that are expected to arise on the sale of assets related to the
clean-up, must be:

a. set-off against the provision for the clean-up.

b. recognised as a deferred asset.
*c. measured separately of the provision.
d. recognised directly in equity in the period in which the cash inflows arise.

Answer: c
Learning objective 8.5: explain how a provision, once recognised, should be measured.
14. Percy Limited is a manufacturer of playground equipment. Percy provides its customers with
five-year warranties from the date of sale. Past experience shows that there will be some
claims under the warranties. The appropriate treatment of this item under AASB 137
Provisions, Contingent Liabilities and Contingent Assets is to:

*a. recognise the best estimate of costs as a provision.

b. disclose in the notes, but do not recognise in the financial statements.
c. charge the costs directly to profit or loss in the period in which the economic outflows
occur.
d. transfer the expected amount of the warranty from retained earnings to a special reserve
account in equity.

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Chapter 8: Provisions, contingent liabilities and contingent assets

Not for distribution in full. Instructors may assign selected questions in their LMS.

Answer: a
Learning objective 8.5: explain how a provision, once recognised, should be measured.

15. Accountants are required to use professional judgement in determining the best estimate of
provisions. Which of the following is an example of when judgement is required?

a. Assessing the likely consideration that will be required to settle the obligation.
b. Determining if various scenarios may arise.
c. Determining when the consideration is likely to be settled.
*d. All of these options.

Answer: d
Learning objective 8.5: explain how a provision, once recognised, should be measured.

16. An entity sells goods under warranty and past experience shows that minor defects account
for 10% of sales and major defects account for 2% of sales. If minor defects were detected in
all goods sold the repair costs would be $260 000, and if major defects were detected in all
goods sold the repair costs would be $990 000. The expected value of the warranty costs is:

a. $ 0.
b. $ 19 800.
*c. $ 45 800.
d. $ 99 000.

Answer: c
Learning objective 8.5: explain how a provision, once recognised, should be measured.

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Testbank to accompany Financial reporting 3e by Loftus et al.

17. The costs under an onerous contract are measured as:

a. the lower of cost or net market value.

b. the present value method using a risk-free discount rate.
c. the unavoidable costs of meeting the obligations discounted by reference to market yields
at reporting date.
*d. the lower of the cost of fulfilling the contract and any compensation or penalties arising
from failure to fulfil the contract.

Answer: d
Learning objective 8.6: apply the definitions, recognition and measurement criteria for
provisions and contingent liabilities to practical situations.

18. Angus Ltd has provided a bank guarantee to a bank in relation to a loan provided to Brown
Ltd. Brown Ltd is solvent and shows no signs of defaulting on the loan. The treatment of the
bank guarantee in the records of Angus Ltd is to:

a. do nothing.
*b. recognise a contingent liability.
c. recognise a liability.
d. recognise a provision.

Answer: b
Learning objective 8.6: apply the definitions, recognition and measurement criteria for
provisions and contingent liabilities to practical situations.

19. AASB 137 Provisions, Contingent Liabilities and Contingent Assets provides the definition
of a/an as:

‘a contract in which the unavoidable costs of meeting the obligations under the contract exceed
the economic benefits expected to be received under it’.

a. future operating loss.

b. deferred liability.
*c. onerous contract.
d. present obligation.

Answer: c
Learning objective 8.6: apply the definitions, recognition and measurement criteria for
provisions and contingent liabilities to practical situations.

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Chapter 8: Provisions, contingent liabilities and contingent assets

Not for distribution in full. Instructors may assign selected questions in their LMS.

20. McAllister Limited announced its plans for a major restructuring of its operations. Under
AASB 137 Provisions, Contingent Liabilities and Contingent Assets, the entity is able to:

a. capitalise all direct and indirect restructuring costs.

b. set up a provision for the best estimate of all restructuring costs.
c. provide for restructuring costs that are associated with the ongoing activities of the entity.
*d. provide only for restructuring costs that are directly and necessarily caused by the
restructuring.

Answer: d
Learning objective 8.6: apply the definitions, recognition and measurement criteria for
provisions and contingent liabilities to practical situations.

21. Under AASB 137 Provisions, Contingent Liabilities and Contingent Assets, the appropriate
accounting treatment for future operating losses is to:

a. determine a reasonable estimate of the future losses and recognise as a provision.

b. determine the future losses and charge them directly against retained earnings.
*c. not recognise such items in the financial statements.
d. determine the future losses and discount them to present value.

Answer: c
Learning objective 8.6: apply the definitions, recognition and measurement criteria for
provisions and contingent liabilities to practical situations.

22. AASB 137 Provisions, Contingent Liabilities and Contingent Assets, defines a
as:

‘a possible asset that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the
control of the entity’

a. deferred liability.
*b. contingent asset.
c. deferred asset.
d. contingent liability.

Answer: b
Learning objective 8.7: outline the concept of a contingent asset.

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Testbank to accompany Financial reporting 3e by Loftus et al.

23. At the end of the financial period, Rosella Limited was awaiting the final details of a court
case for damages awarded in its favour. The amount and possible receipt of damages is
unknown and will not be decided until the court sits again in approximately three months’
time. How should Rosella Limited recognise this situation when preparing the financial
statements?

*a. Disclose in the notes to the financial statements as it is possible that the entity will receive
the damages and the court decision is out of its control.
b. Do not recognise or disclose in the financial statements as the possibility of receiving
damages is remote.
c. Recognise as an asset in the financial statements as the receipt of damages is probable.
d. Recognise as a deferred asset in the statement of financial position and re-classify as a non-
current asset when the court decision is known.

Answer: a
Learning objective 8.7: outline the concept of a contingent asset.

24. As per AASB 137 Provisions, Contingent Liabilities and Contingent Assets, the appropriate
treatment for a contingent asset in the financial statements of an entity is:

a. recognition in the financial statements, and note disclosure.

b. recognition in the financial statements, but no further disclosure in the notes.
c. do not recognise in the financial statements, and do not disclose in the notes.
*d. disclosure of information in the notes, but do not recognise in the financial statements.

Answer: d
Learning objective 8.7: outline the concept of a contingent asset.

25. In respect to a contingent liability, AASB 137 Provisions, Contingent Liabilities and
Contingent Assets, requires disclosure of:

*a. an estimate of its financial effect.

b. any increase in the contingent liability during the period.
c. the carrying amount at the beginning and end of the period.
d. an indication of the uncertainties about the amount and timing of expected outflows.

Answer: a
Learning objective 8.8: describe the disclosure requirements for provisions, contingent liabilities
and contingent assets.

© John Wiley and Sons Australia, Ltd 2020 8.9

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Chapter 8: Provisions, contingent liabilities and contingent assets

Not for distribution in full. Instructors may assign selected questions in their LMS.

26. For each class of provision, AASB 137 Provisions, Contingent Liabilities and Contingent
Assets requires an entity to disclose the following information:

I Comparative information.
II Unused amounts reversed during the period.
III Additional provisions made during the period.
IV The carrying amount at the beginning and end of the period.
V A brief description of the nature of the obligation and the expected timing.

a. I, II, and III only.

*b. II, III, IV and V only.
c. II, III and IV only.
d. I, III, IV and V only.

Answer: b
Learning objective 8.8: describe the disclosure requirements for provisions, contingent liabilities
and contingent assets.

27. Entities are not required to disclose which of the following in relation to provisions?

*a. Comparatives.
b. Amounts used during the period.
c. The effect of any change in the discount rate used.
d. Carrying amounts of provisions at the beginning of the period.

Answer: a
Learning objective 8.8: describe the disclosure requirements for provisions, contingent liabilities
and contingent assets.

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