9/20/2022

Chapter 11 • IAS 37 Provisions, contingent

liabilities and contingent assets

Provisions and
contingencies

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Overview

Accounting treatment Recognition criteria

Provisions

Provisions and
contingencies

Contingent liabilities Contingent assets

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IAS 37 Provisions, contingent liabilities and contingent assets

Provision
• A liability of uncertain timing or amount
• The amount recognised as a provision should be the best
estimate of the expenditure required to settle that present
obligation.

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• A business has been told by its lawyers that it is likely to

have to pay $10,000 damages for a product that failed.
The business duly set up a provision at 31 December
20X7. However, the following year, the lawyers found that
damages were more likely to be $50,000.
• How is the provision treated in the accounts at:
(a) 31 December 20X7?
(b) 31 December 20X8?

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• (a) 31 December 20X7

DEBIT Damages (SPL) $10,000
CREDIT Provision (SOFP) $10,000
• EXTRACT FROM STATEMENT OF PROFIT OR LOSS
Expenses
- Provision for damages $10,000
• EXTRACT FROM STATEMENT OF FINANCIAL POSITION
Non-current liabilities
- Provision for damages $10,000

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• (b) 31 December 20X8

DEBIT Damages (SPL) $40,000
CREDIT Provision (SOFP) $40,000
• EXTRACT FROM STATEMENT OF PROFIT OR LOSS
Expenses
- Provision for damages $40,000
• EXTRACT FROM STATEMENT OF FINANCIAL POSITION
Non-current liabilities
- Provision for damages $50,000
(10,000 + 40,000)

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Measurement of provisions

• Parker Co sells goods with a warranty under which

customers are covered for the cost of repairs of any
manufacturing defect that becomes apparent within the
first six months of purchase. The company's past
experience and future expectations indicate the following
pattern of likely repairs.
% of goods sold Defects Cost of repairs ($m)
75 None –
20 Minor 1.0
5 Major 4.0
What should the warranty provision in Parker Co's financial
statements be?

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Answer

• Parker Co should provide on the basis of the expected

cost of the repairs under warranty.
The expected cost is calculated as

Parker Co should include a provision of in the

financial statements

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IAS 37 (cont'd)

Contingent liability
• A possible obligation that arises from past events, whose
existence will be confirmed by the occurrence or
non-occurrence of future events not wholly in the entity's
control.
• A present obligation not recognised because:
— It is not probable that settlement of the obligation will be
required.
— The amount cannot be measured.
• Contingent liabilities should be disclosed in the notes

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IAS 37 (cont'd)

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IAS 37 (cont'd)

Contingent asset
• A possible asset that arises from past events and whose
existence will be confirmed by the occurrence of one or
more uncertain future events not wholly within the entity's
control.
• A contingent asset must not be recognised in the
accounts, but should be disclosed if it is probable that
the economic benefits associated with the asset will flow to
the entity
• If the flow of economic benefits associated with the
contingent asset becomes virtually certain, it should then
be recognised as an asset in SOFP.

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Lecture example 1

Grass Co is reviewing its warranty obligations. Based on sales during

20X7 it has established that if all lawnmowers sold required minor
repairs this would cost $1m whereas if major repairs were required this
would cost $6m.
Grass Co expects that 75% of lawnmowers will have no faults, 20% will
need minor repairs and 5% major repairs.

Required
(a) What provision should be made in 20X7 and what accounting
entry is needed to record it?
(b) What entry should be made in 20X8 assuming the provision
required then is $0.75m?
(c) What entry should be made in 20X9 assuming the provision
required then is $0.3m?

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Answer to lecture example 1

(a) A provision should be made using expected values:

(b) In 20X8 the provision needs to increase by

(c) In 20X9 the provision needs to decrease by

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Example 2
• Should a provision be recognized in the accounts of
Prudence for the following items? If not, how should they
be treated in the financial statements?
a. Prudence is a retail store and has a policy of refunding
purchases by dissatisfied customers, even though there
is no legal obligation to do so. Its policy of making
refunds is generally known.
b. Prudence is being sued for $100,000 damages. Counsel
assesses the chance of losing the case as fifty fifty.
c. Prudence is suing another company for $50,000
damages. At the date on which the financial statements
are approved, council’s opinion is that Prudence is likely
to win the case and receive the damages

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• Warren Tees Ltd. is a manufacturer of golf tees. Tees

purchased are covered by a three year warranty, whereby
the company will replace any defective tees.
At the end of last year on 31 March 20X6, a provision of
$150,000 was made. During this year, $75,000 was paid
for the cost of replacing tees under warranty. At the end of
this year, the company estimated that a provision of
$135,000 was needed

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Chapter 12 • Irrecoverable debts and

receivables allowances
• Accounting for irrecoverable debts
Irrecoverable debts and receivables allowances
and allowances

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Overview
Amounts recovered

Irrecoverable debts

Irrecoverable debts
and allowances

Allowance for receivables

Allowances

Equivalent to a % of the
Specific
remaining balance

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Irrecoverable debts and receivables allowances 1

• A receivable should only be classed as an asset if it is

recoverable.
Irrecoverable debt is a debt which is definitely not
expected to be paid.
• If definitely irrecoverable, it should be written off to the
statement of profit or loss as an irrecoverable debt.

DEBIT Irrecoverable debt expense (SPL)

CREDIT Trade receivables (SOFP)

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Accounting for irrecoverable debts and receivables

allowances 5

Subsequent recovery of debts

• If an irrecoverable debt is recovered, having previously
been written off, then:

DEBIT Cash (SOFP)

CREDIT Irrecoverable debts expense (SPL)

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Tackling the exam

Exam focus point:

In the exam it is highly likely that you will have to calculate

the increase or decrease in the allowance for receivables
and show the effect of this on the statement of profit or loss.

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Lecture example 1

Fight & Co has trade receivables at 31 December 20X7 of

$65,000. A review of customer files indicates that two
customers, Ali and Tyson, which owe $7,000 and $8,000
respectively, have gone bankrupt and their debts are
considered irrecoverable.

Required
(a) Calculate the balance c/d on the trade receivables
account at the end of the year.
(b) Calculate the irrecoverable debt expense shown in the
statement of profit or loss.

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Answer to lecture example 1

(a) The balance c/d on the trade receivables account at the

end of the year is

(b) The irrecoverable debt expense shown in the SPL is

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Answer to lecture example 1 (cont'd)

Workings
Trade receivables (SOFP)
$ $

Irrecoverable debt expense (SPL)

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• In addition to irrecoverable debts, a business may make

an allowance for receivables as a prudent precaution to
account for the fact that some receivables balances are
doubtful and might not be collectable. (i.e Customers
are in financial difficulty).
• In this situation, such debts are not written off
• An increase in the allowance for receivables is shown as
an expense in the statement of profit or loss.
• Trade receivables in the statement of financial position are
shown net of any receivables allowance.

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Allowance for Receivables

• If uncertainty exists as to the recoverability of the debt, an

allowance should be set up.
DEBIT Irrecoverable debt expense (SPL)
CREDIT Allowance for receivables (SOFP)
• Allowances can either be specific, against a particular
receivable, or against a proportion of all receivables not
specifically allowed for.
• In this paper, the allowance is likely to be expressed as a
percentage of trade receivables, eg an allowance equivalent to
2% of trade receivables.
• The allowance against the trade receivables balance is made
after writing off any irrecoverable debts.

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Accounting for irrecoverable debts and receivables

allowances 1

Allowances for receivables

• When calculating the allowance to be made, the following
order applies.
$
Receivables balance per receivables control account X
Less: irrecoverable debts written off (X)
amounts specifically allowed (X)
Balance on which allowance is calculated X

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• When an allowance is first made, the amount of this initial

allowance is charged as an expense in the SOPL for the
period in which the allowance is created.

• When an allowance already exists

o Increased in size, the amount of the increase in allowance is
charged as an expense in the SOPL
o Reduced in size, the amount of the decrease in allowance is
credited back to the SOPL

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Accounting for irrecoverable debts and receivables

allowances 2

• Note. Only the movement in the allowance needs to be

charged or credited to the SPL.
$
Allowance required X
Existing allowance (X)
Increase/(decrease) required X/(X)

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Accounting for irrecoverable debts and receivables

allowances 3

• If a reduction in the receivables allowance is required,

then:
DEBIT Allowance for receivables (SOFP)
CREDIT Irrecoverable debts expense (SPL)

• If a increase in the receivables allowance is required, then:

DEBIT Irrecoverable debt expense (SPL)
CREDIT Allowance for receivables (SOFP)

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Lecture example 2

A further review of Fight & Co's customer files indicates there

is some uncertainty as to whether a debt of $3,500 owed by
Bugner is recoverable.
(a)Calculate the allowance for receivables shown on the
statement of financial position.
(b)Calculate the allowance for receivables expense shown in
the statement of profit or loss.
(c) Show how the information from Lecture examples 1 and 2
would be shown in extracts from the statement of profit or
loss and statement of financial position.

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Answer to lecture example 2

Allowance for receivables:

(a) The allowance for receivables shown on the statement of
financial position is

(b) The allowance for receivables expense shown in the SPL

is

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Answer to lecture example 2 (cont'd)

Workings
Allowance for receivables (SOFP)
$ $
Bal c/d 3,500 Allowance for receivables 3,500
expense

Allowance for receivables expense (SPL)

$ $
Allowance for receivables 3,500 SPL 3,500

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Answer to lecture example 2 (cont'd)

STATEMENT OF PROFIT OR LOSS (extract)

$
Expenses
Irrecoverable debts (see Lecture Example 1) (15,000)
Allowance for receivables expense (3,500)

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Answer to lecture example 2 (cont'd)

STATEMENT OF FINANCIAL POSITION (extract)

$
Current assets
Trade receivables 50,000
Less: allowance for receivables (3,500)
46,500

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Lecture example 3

A business's trade receivables account showed a year end balance of

$47,440. It was decided that amounts totaling $340 should be written off
as irrecoverable, a specific allowance was to be made against an amount
of $400 due from Dodgy Co, a customer, and a further allowance for
doubtful receivables equivalent to 2% of the remaining outstanding
receivables was to be created.

Required
(a) Calculate the allowance for receivables shown in the
statement of financial position.
(b) Calculate the total receivables expense shown in the
statement of profit or loss.

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Answer to lecture example 3

(a) The allowance for receivables shown in the statement

of financial position is $
(b) The total receivables expense (irrecoverable debt and
allowance for receivables expense) shown in the
statement of profit or loss is $

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Answer to lecture example 3 (cont'd)

Workings
(W) Allowance for doubtful debts:
$
Trade receivables (net of irrecoverable debts written off)
Less: specific allowance

Total allowance =

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Lecture example 4

Fight & Co (see Lecture example 1) subsequently receive a

cheque of $7,000 from Ali.

Required
Show the treatment of this recovery in the relevant 'T'
accounts.

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Answer to lecture example 4

Irrecoverable debts recovered

Trade receivables (SOFP)
$ $
1.1.X8 Bal b/d 50,000

Irrecoverable debt expense (SPL)

$ $
SPL 7,000 Cash 7,000

Cash (SOFP)
$
Irrecoverable debt expense 7,000

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Lecture example 5

Required
Show the accounting treatment for Fight & Co if, having
made a specific allowance (see Lecture example 2), during
the next year Bugner repays his debt of $3,500 to Fight & Co
in cash?

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Lecture example 6

Required
Following on from the information used in Lecture example 2,
suppose that in the next accounting period, the debt from
Bugner is considered to be irrecoverable.

What double entry would be required to record this?

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Lecture example 7

The following information is available for A Co:

Year ended 31 December 20X7: Trade receivables $20,000

Year ended 31 December 20X8: Trade receivables $30,000

A Co requires an allowance equivalent to 5% of trade

receivables in each year.

Required
Show the required adjustment to the allowance for
receivables account in the year ended 31 December 20X8.

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Lecture example 8

At 30 September 20X7 G Co had an allowance for receivables of

$24,000.
During the year ended 30 September 20X8 G Co recovered
$2,000 from a customer whose balance was written off in 20X7
and wrote off further debts totaling $18,000. The closing allowance
for receivables is required to be $21,000. No adjustments have
been made for this information.
Required: What amount should appear in the statement of profit or
loss for the year ended 30 September 20X8 for the above items?
A $13,000
B $15,000
C $17,000
D $23,000
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Chapter 13 • Nature and collection of sales tax

• Accounting for sales tax

Sales tax

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Overview

Output tax Input tax

Accounting treatment

Sales tax

Irrecoverable sales tax Discounts

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Nature and collection of sales tax 1

Sales tax
• Is an indirect tax levied on the sale of goods and services
• Administered by tax authorities
• Can have a number of rates, eg standard rate, reduced
rate

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Nature and collection of sales tax 2

Output sales tax

• Sales tax charged by the business on goods/services

Input sales tax

• Sales tax on purchases made by the business

Output tax greater than input?

• Pay difference to tax authorities

Input tax greater than output?

• Refund due to business
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Lecture example 1

A business buys goods for $1,000 plus 15% sales tax. They then sell those
goods for $1,500 + 15% sales tax.

The purchases will cost ($1,000 × 1.15) = $1,150

The sales will raise ($1,500 × 1.15) = $1,725

The sales tax payable to tax authorities will be:

Payable on outputs (sales) (15% × $1,500) 225.00

Reclaimable on inputs (purchases) (15% × $1,000) (150.00)
Net sales tax to tax authorities 75.00

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Lecture example 1 (cont'd)

As the business is purely collecting the sales tax for the tax authorities,
and is able to set off its sales tax suffered it does not include sales tax
as either an expense or income in the statement of profit or loss. The
sales tax is accounted for when the transaction occurs.

Required
(a) Post the double entry to the ledger account below.
$ $
Dr Purchases 1,000
Dr Sales tax control account 150
Cr Trade payables 1,150

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Lecture example 1 (cont'd)

(b) Post the double entry to the ledger account below.

$ $
Dr Trade receivables 1,725
Cr Sales 1,500
Cr Sales tax control account 225

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Answer to lecture example 1

Purchases
$
Trade payables 1,000

Trade payables
$
Purchases 1,150

Trade receivables
$
Sales 1,725

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Answer to lecture example 1 (cont'd)

Sales tax control a/c
$ $
Trade payables 150 Trade rec. 225

Sales
$ $
Trade rec. 1,500

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Irrecoverable sales tax

 Sales tax may not be recoverable on certain purchases.

Where this is the case the question will state that the sales
tax is not recoverable and the cost recorded will be the
gross amount.
 For example, if a business pays $500 for entertaining
expenses and suffers irrecoverable input sales tax of $75
on this amount, the total of $575 paid should be charged
to the statement of profit or loss as an expense.

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• W is registered for sales tax. The managing director has

asked four staff in the accounts department why the output
tax for the last quarter does not equal 20% of sales (20%
is the rate of tax). Which one of the following four replies
she received was NOT correct?
A. The company had some exports that were not liable to
sales tax.
B. The company made some sales of zero-rated products.
C. The company made some sales of exempt products.
D. The company sold some products to businesses not
registered for sales tax.

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• Alana is not registered for sales tax purposes. She has

recently received an invoice for goods for resale which
cost $500 before sales tax, which is levied at 15%. The
total value was therefore $575.
What is the correct entry to be made in Alana's general
ledger in respect of the invoice?
A. DEBIT Purchases $500, DEBIT Sales tax $75, CREDIT
Payables $575
B. DEBIT Purchases $575, CREDIT Sales tax $75, CREDIT
Payables $500
C. DEBIT Purchases $500, CREDIT Payables $500
D. DEBIT Purchases $575, CREDIT Payables $575

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• The following information relates to Eva Co's sales tax for

the month of March 20X3:
• Sales (including sales tax) $109,250
• Purchases (net of sales tax) $64,000
• Sales tax is charged at a flat rate of 15%. Eva Co's sales
tax account showed an opening credit balance of $4,540
at the beginning of the month and a closing debit balance
of $2,720 at the end of the month.
• What was the total sales tax paid to regulatory authorities
during the month of March 20X3?

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• Information relating to Lauren Co's transactions for the

month of May 20X4 is shown below:
• Sales (including sales tax) $140,000*
• Purchases (net of sales tax) $65,000
• Sales tax is charged at a flat rate of 20%. Lauren Co's
sales tax account had a zero balance at the beginning of
the month and at the end of the month.
• * Lauren Co's sales for the month of $140,000 included
$20,000 of sales exempt from sales tax.
• What was the total sales tax paid to regulatory authorities
at the end of May 20X4 (to the nearest $)?

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