CH4 – PROVISIONS, CONTINGNENT LIABILITIES CONTINGENT LIABILITY

AND CONTINGENT ASSETS - Are liabilities and assets that are not recognized
because they do not meet all of the recognition
criteria
PROVISIONS - Are disclosed only except when the possibility of an
- A liability of uncertain timing or amount outflow of resources embodying economic benefits
- It differs from other liabilities because of the is removed
uncertainty in the timing of their settlement or the
amount needed to settle them PROVISION CONTINGENT LIABILITY
- Must necessarily be estimated A liability of uncertain A possible obligation has
- Separately presented from other liabilities in the timing or amount that existence will be confirmed only
statement of financial position meets all the following by the occurrence or
conditions: nonoccurrence of one or more
a. Present obligation uncertain future events not wholly
EXAMPLES OF PROVISIONS b. Probable outflow within the control of the entity
- Warranty obligations c. Reliably estimated
- Estimated liabilities on pending lawsuits A present obligation but:
- Provisions for environmental damages a. It is not probable that it will
- Provisions for decommissioning costs of an item of cause an outflow in its
PPE settlement
b. Its amount cannot be reliably
- Obligations caused by an entity's policy to make estimated
refunds to customers
- Obligations arising from guarantees
- Provisions on onerous contracts
- Provisions for restructuring costs CONTINGENT ASSETS
- Similar definition with contingent liability
- Includes claims that an entity is seeking through
4.1 RECOGNITION legal processes where the outcome is uncertain
- A provision is recognized when ALL of the following - Not recognized because they do not meet the asset
conditions are met: recognition criteria
a. Entity has a present obligation resulting from a past - Disclosed if the inflow of economic benefits is
event probable
b. It is probable that an outflow of resources - An asset is not a contingent asset if the realization of
embodying economic benefits will be required to income is virtually certain
settle the obligation
Contingen
c. The amount of the obligation can be reliably t
Probable Possible Remote
estimated PROVISION CONTINGENT
- No provision is recognized for future operating costs Liability Recognize & LIABILITY Ignore
- Liabilities are only recognized when they exist at the Disclose Disclose only
end of the existing reporting period CONTINGENT
Asset ASSET Ignore Ignore
- It is not necessary that the identity of the obligee is Disclose Only
known

PRESENT OBLIGATION 4.2 MEASUREMENT OF PROVISIONS

It can exist if available evidence shows that it is more MEASUREMENT
likely than not that a present obligation exists at the end NATURE OF THE OUTFLOW
BASIS
of the reporting period. 1. General Rule
Best Estimate
(one-off event)
OBLIGATING EVENT Expected value
2. Involves a large population of
It is a past event that creates a present obligation (Probability Weighted
items
Average)
It is when an entity does not have any other recourse but 3. Each possible outcome in a
to settle an obligation Mid-Point
range is as likely as any other
This is the case when:
1. The obligation is legally enforceable (legal RECORDING THE PROVISION
obligation) - Provisions are normally recognized as a debit to
2. The entity's actions have created valid expectations expense (or loss) and a credit to an estimated
from others that the entity will discharge the liability account.
obligation (constructive obligation) - Sometimes provisions are part of the cost of an
asset. Ex. Provision for restoration and
PROBABLE OUTFLOW OF RESOURCES decommissioning costs or capitalized as part of the
EMBODYING ECONOMIC BENEFITS cost of a PPE.
1. PROBABLE
- More likely than not RISK AND UNCERTAINTIES
- There is a higher chance that the event will cause an - Estimates may be increased by a risk adjusting
outflow of future economic benefits than not factor to provide an allowance for imprecision
- 51% or more inherent in estimates

2. POSSIBLE
- 50:50 chance
 - If another party is expected to reimburse the
settlement amount of a provision
PROVISIONS MEASUREMENT BASIS - It is recognized if it is virtually certain that the
1. BEST ESTIMATE reimbursement will be received
- Presented in the statement of financial position
1. Is there a present obligation arising from past events? separately from the provision
2. Is the outflow probable? - Presented in the statement of comprehensive
3. Can the outflow be measured reliably? income where the expense related to provision
All answers must be YES, if not then provision is not presented net of the reimbursement
recognized
- Reimbursement amount should not exceed provision
2. EXPECTED VALUE
Repair Cost Probability Expected Value
amount
a b c=axb
20,000,000 5% 1,000,000 DEDUCTIBLE CLAUSE
15,000,000 20% 3,000,000
10,000,000 35% 3,500,000 - The amount of loss that the insured must first pay
5,000,000 45% 2,000,000 before any excess loss is shouldered by the
100% 9,500,000 insurance company
3. MID-POINT
Mid-Point = REIMBURSEMENTS
Est . Minimum + Est . Maximum Dec.31,20x1
Loss on fire
Est. liability on casualty
50,000

50,000
2 Insurance claims receivable 20,000
Dec.31,20x1 Gain on Insurance
20,000
4.3 PRESENT VALUE DEDUCTIBLE CLAUSE
- Disclosure only, IF there is no present obligation as of
- If the effect of time value of money is material, the Dec.31, 20x1
estimate of a provision is discounted to its present - Provision exists, IF there is a present obligation as of
Dec.31, 20x1
value using a pretax discount rate.
- Ex. revisions for restoration and decommissioning
costs where cash outflows occur only after a 4.7 CHANGES IN PROVISION
relatively long period of time from the date of initial
- Changes in provisions are accounted for
recognition.
prospectively by accruing an additional amount or
by reversing a previously recognized amount
PRESENT VALUE CALCULATIONS - If provision is discounted, the unwinding
Minor Repairs (10M x 3% x 10%) 30,000
Major Repairs (10M x 2% x 90%) 180,000 (amortization) of the related discount which
Total Warranty repair costs for the 20x1 sales 210,000 increases the carrying amount of the provision, is
Multiply by: Portion to be settled in 20x2 50% recognized as interest expense
Warranty repair costs not yet paid as of Dec.3,20x1
105,000
An entity recognizes provision of P500,000 for probable
Multiply by: Risk Adjustment (100% + 6%) 106%
loss on a pending lawsuit
Total 111,300
Probable loss on lawsuit 500,000
Multiply by: Present Value factor 0.95238 Dec.31,20x1 Est. liab. on pending lawsuit
Warranty provision – Dec. 31, 20x1 106,000 500,000
At 20% chance (200k x 20%) 40,000 The lawsuit remains unsettled. The entity reviews its position
At 80% chance (100k x 80%) 80,000 on the case and revises its estimate of loss to P700,000
Total at 100% chance of settlement 120,000 Probable loss on lawsuit 200,000
Multiply by: Probability of settlement (100-30) 70% Dec.31, 20x2 Est.liab. on pending
Probability-weighted expected cash flows 84,000 200,000
lawsuit
Multiply by: Risk adjustment (100% + 7%) 107% Scenario 1: The entity settles the lawsuit for 850,000
Total 89,880 20x3 Est. liab on pending lawsuit 700,000
Multiply by: PV of P1 @10%, n=1 0.90909 Loss on lawsuit 150,000
Provision for pending lawsuit – Dec.31,20x1 81,709 Cash
850,000
4.4 FUTURE EVENTS Scenario 2: The entity settles the lawsuit for 600,000
20x3 Est. liab on pending lawsuit 700,000
- Are considered in estimating a provision only if there Cash
600,000
Gain on settle. of
is objective evidence that supports their anticipation provision 100,000
- Ex. penalty for an environmental damage may be Scenario 3: The entity wins the case and base nothing
affected by legislation 20x3 Est. liab on pending lawsuit 700,000
Gain on settle. of
provision 700,000
4.5 EXPECTED DISPOSAL OF ASSETS

- Gains from the expected disposal of assets are not 4.8 APPLICATION OF THE RECOGNITION AND
taken into account when measuring a provision MEASUREMENT RULES
- Gains are recognized separately when the disposals
FUTURE OPERATING LOSSES
occur
- No provision is recognized because they do not
meet the definition of a liability
4.6 REIMBURSEMENT
ONEROUS CONTRACTS
REIMBURSEMENT ASSET
- The provision recognized from an onerous contract 3. Guarantee of indebtedness of others becoming
reflects the least net cost of exiting from the contract probable

LEAST NET COST 1. PRODUCT WARRANTIES AND GUARANTEES

- The lower of the cost of fulfilling it and any
compensation or penalties arising from failure to
fulfill it
LOSS ON PURCHASE COMMITMENT
- It is recognized only for guaranteed
purchases.
- Present obligation for warranty arises from sale
- A provision is made if the cost of discharging the
warranty obligation is judged to be significant
- A provision is not recognized if it is insignificant,
only expense is recognized when the warranty is
future actually discharged

ONEROUS CONTRACT – PURCHASE COMMITM. PAS 37 PFRS 15

Guaranteed minimum annual purchase (in units) 15,000 Provisions, contingent Revenue from
Multiply by: Remaining years in the contract 2 liabilities, and contracts with
Total goods to be accepted in the future 30,000 contingent assets customers
Multiply by: Purchase price less scrap value 20
If the customer does not If the customer has the
Loss on purchase commitment – Dec.31,20x1
have the option to purchase option to purchase a
600,000
a warranty separately warranty separately
Loss on fire 600,000
Dec.31,20x1 Est. liability on casualty
600,000 WARRANTY
Total units sold in 20x1 5,000
4.9 RESTRUCTURING Multiply by: Est. warranty cost per unit 100
Warranty expense in 20x1 500,000
RESTRUCTURING Warranty expense 500,000
Dec.31,20x1 Est. warranty liability
- A program that is planned and controlled by To record provision for 500,000
warranty costs
management, and materially changes either: Est. warranty liability 310,000
a. The scope of a business undertaken by an entity; or Dec.31,20x1 Cash/cost replacement
To record the actual warranty 310,000
b. The manner in which that business is conducted costs
Est. Warranty Liability
EXAMPLES OF RESTRUCTURING xx Jan 1, 20x1
1. Sale or termination of a line of business Beginning
2. Closure of business locations in a country or region Actual warranty costs xx xx Warranty Expense
or the relocation of business activities from one Dec 31, 20x1 End
country or region to another xx
3. Changes in management structure, for example,
eliminating a layer of management; and 2. LIABILITY FOR PREMIUM
4. Fundamental reorganizations that have a material
effect on the nature and focus of the entity's PREMIUMS
operations - Are promotional items that are linked to a product,
and often require proofs of purchase to acquire.
ADDITIONAL CONSIDERATIONS WHEN PAS 37 PFRS 15
RECOGNIZING PROVISIONS FOR RESTRUCTURING Provisions, contingent Revenue from
COSTS liabilities, and contracts with
- Accrue a (legal obligation) contingent assets customers
1. SALE OF provision only if a binding sale - If a customer option to
OPERATION agreement is obtained on or acquire additional goods or
before the end of the reporting. services for free or at a
- If a customer option
- Accrue a (constructive obligation) discount
does not provide the
provision only if a detailed - The option provides the
customer with a
formal plan is adopted and customer a material ride
2. CLOSURE OR material right
announced publicly on or that the customer would not
REORGANIZATION
before the end of the reporting. receive without entering
- A mere board decision to into the contract
restructure is not enough.
- Accrue a provision for terminating PREMIUMS
employees, closing facilities, and
Sales in units 500,000
eliminating product lines only if
3. RESTRUCTURING Multiply by: Est. warranty cost per unit 40%
announced at acquisition and,
PROVISION ON Est. number of wrappers to be redeemed 200,000
then only if a detailed formal
ACQUISITION Divided by: No. of wrappers per set of kitchen knives 10
plan is adopted within a short
(MERGER) Est. number of sets of kitchen knives to be distributed
period of time after acquisition
20,000
- It excludes costs that relate to the
Multiply by: Net Cost 150
new business.
Premium Expense 3,000,000
4. FUTURE - Provisions are not recognized Premium 60,000,000
OPERATING for operating losses, even in a Cash
Dec.31,20x1
LOSSES restructuring To record purchase of 60,000,000
the premium
Premium expense 3,000,000
Est. liab for
4.10 OTHER COMMON TYPES OF PROVISIONS Dec.31,20x1 premiums 3,000,000
To record provision for
1. Product warranties and guarantees premium
2. Premiums
 Cash 225,000
Est. liab for premium 675,000
Dec.31, 20x1 Premium
To record the actual
redemption in 20x1 900,000

Est. Warranty Liability

xx Jan 1, 20x1
Beginning
Actual premiums xx xx Premium Expense
Dec 31, 20x1 End
xx

3. GUARANTEE OF INDEBTEDNESS
- The guarantor does not recognize any liability when
the guarantee is made
- If probable that the guarantor will be held liable for
the guarantee, such as when the original debtor
defaults on the loan, a provision is recognized for
the estimated amount the guarantor will be held by
above for the guarantee