159 Chapter 4 Provisions, Contingent Liabilities and Contingent Assets Related standard: PAS 37 Provisions, Contingent Liabilities and Contingent Ass tives [Zearning Objec i Identify the existence of a provision, contingent liability and | contingent asset. | 2, State the recognition criteria and the available measurement bases for provisions. 3,_Determine when a contingent item should be disclosed, Provisions is “a liability of uncertain timing or amount.” (PAs37.10) Prov ns differ from other liabilities because of the uncertainty in the timing of their settlement or on the amount needed to settle them, Unlike other liabilities, provisions must necessarily be estimated. Although some other liabilities are also estimated, their uncertainty is generally much less compared to provisions. Examples of provisions: a. Warranty obligations b. Estimated liabilities on pending lawsuits Provisions for environmental damages Provisions for decommissioning costs of an item of PPE Obligations caused by an entity’s policy to make refunds to Customers « da. e Obligations arising from guarantees - Provisions on onerous contracts (e.g., purchase commitment) ' Provisions for restructuring costs Provisions are presented in the statement of financial Postion separately from other types of liabilities. Sere Scanned with CamScanner4 h hy ! ' apreenl recognized when all of the following « od, m , a. ‘The entity has a_ pres resulting from a past event; b. It is probable that an outtlow of resources embody, economic benefits will be required t0 settle the obligation, ©. The amount of the obligation can be reliably estimated, at obligation (legal OF consiny i If any of the conditions is not met, no Provision « recognized. (PAS37.14) Present obligation In rare cases where it is not clear whether there isa pres obligation, an entity deems a past event to give rise to a pres Obligation if available evidence shows that it is more likely than yy that a present obligation exists at the end of the reporting period. Past event A past event that creates a present obligation is called x obligating event. An obligating event is one whereby the enti does not have any other recourse but to settle an obligation. This is the case where: a. the obligation is legally enforceable (legal obligation); or b. the entity’s actions (e.g, past practice or published poli! have created valid expectations from others that the entiy il discharge the obligation (constructive obligation). Financial statements deal with past or historia! information. Therefore, no provision is recognized for ful operating costs. “The only liabilities recognized in an enlill® statement of financial position are those that exist at the end of! reporting period.” (pas 37.18) Only those obligations arising from past events © independently of an entity's future actions are recognized” provisions. Thus, possible outflows of resources embod)® 7 Scanned with CamScanner xistitOY J, Conti sions, Contin {Hiabitities and Contingent Asset prose ~ 161 economic benefits that the entity can av id by changing setions are not recognized as provision, AINA Hts future Although an obligation always involve another whom the obligation is owed (i.e, oblipea), it je Party to Hot necessary thal the identity of the obligee is known ~ indeed the aling e t the public at large (c.g, liability for environmental For a constructive obligation to create a valid expectation from others, it is necessary that the commitment must have been communicated to the parties concerned as of the end of the reporting period. nay be amares), Probable outflow of resources embodying economic benefits Probable means “more likely than not,” ic, there is a higher chance that the event will cause an outflow of future economic benefits than not. We may think of it as a “51% or more” chance that the outflow will occur. If it is ‘50:50’, then it is not probable because there are equal chances of occurrence and nonoccurrence, A '50:50' chance is “possible” but not “probable.” Reliable estimate of the obligation Provisions necessarily need to be estimated. If a reliable estimate cannot be made, no provision is recognized. Contingent liabilities In a general sense, all provisions are contingent because they are of uncertain timing or amount. However, PAS 37 uses the term “contingent” to refer to those liabilities and assets that are not recognized because they do not meet all of the recognition criteria. A provision and a contingent liability are differentiated below: —_——————1 Scanned with CamScanner162 Chap Provision Contingent liability |_ Contin; > A liability of an uncertain | > A possible obligation yj, existence will be COMfinn only by the’ occurrency non-occurrence Of ong : more uncertain future evens, not wholly within the can of the entity; or > Apresent obligation but: i, it is not_probable that i will cause an outfloyy ig its settlement; or ii, its amount cannot_& reliably estimated, timing or amount that meets all the following conditions: a. present obligation b. probable outflow c. reliably estimated Contingent liabilities are disclosed only, except when the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets A contingent asset is “a possible asset that arises from past even’: and whose existence will be confirmed only by the occurrence ot non-occurrence of one or more uncertain future events not wholly within the control of the entity.” (PAS37.10) Continent assets include claims that an entity is seeking through legal processes where the outcome is uncertain, such disputed claim for tax refund and disputed insurance claim. Contingent assets are not recognized because they dom! meet the asset recognition criteria, Recognizing a contingent a may result to the recognition of income that may never realized. Although not recognized, contingent assets are disclose! if the inflow of economic benefits is probable. An asset is not a contingent asset if the realization income is virtually certain (100% chance of occurrence). In SY cases, the asset is appropriately recognized, sa Scanned with CamScannerContingent asset ngent asset lustration 1: Con Mpc Co. is involved in a x dispute. ABC Co. is claiming that it fas made an overpayment of taxes and is now demanding a vfand from the BIR. As of December 31, 20x1, ABC Co.'s attomey ie very confident he will win the case in the coming year and recover the tax claim of PIOM. What is the entry to recognize the probable receipt of the tax refund? Answer: None. Contingent assets are disclosed only when they are deemed probable. If possible or remote, contingent assets are not required to be disclosed. Illustration 2: Virtually certain In 20x1, there was a robbery in one of ABC Co.'s branches. There has been a dispute on the P100M insurance claim that ABC Co. has presented to its insurance provider. On December 31, 20x1, the insurance company approved the payment of 80% of ABC Co.'s daim and notified ABC Co. that the check had been mailed. However, ABC Co. received the check only on January 5, 20x2, What is the entry on December 31, 20x1? Answer: Dé : ae Claims receivable (100M x 80%) 80,000,000) Gain on settlement of insurance 80,000,000 a isu in, Therefore, The claim is not a contingent asset because it is virtually certam There ireagtag “gnition is appropriate. Pr TT Scanned with CamScannerMeasurement of provisions Provisions are measured at the best estimate of the amy, needed to settle them as at the end of the reporting period. Making the estimate requires management's judgmen, supplemented by experience from similar transactions, ang ; some cases, reports from independent experts. The estimate considers events after the reporting period. If the provision being measured involves a large popu of items, the obligation is measured at its “expected valy, Expected value is computed by weighting all possible outcomes their associated probabilities. If there is a continuous range of possible outcomes, and ez, point in that range is as likely as any other, the mid-point of range is used. Q Nature of the outflow |_ Measurement basis | 1. General rule (e.g. one-offevent) | > Best estimate 2. Involvesa large populationof | > . Expected value items (Probability Weighted |___ Average) > Mid-point |'3. Each possible outcome in a range is as likely as any other Recording the provision Provisions are normally recognized as a debit to expense (or [os:) and a credit to an estimated liability account. Howevet sometimes a provision forms part of the cost of an asset. For example, provisions for restoration and decommissioning cos are capitalized as part of the cost of a PPE. Illustration 1: Best estimate In 20x1, ABC Co. received a court order requiring the cleanup environmental damages caused by one of ABC’s factory. ABC h# no other realistic alternative but to comply with the court orde* Other entities have incurred around P15M for similar cleanuf’ however, ABC's best estimate of the cost of cleanup is P20M. ei Scanned with CamScanner| Js there a present obligation arising from past event? ~ Yes, environmental Ste Tees have already been caused. mental step 2: Is the outflow probable? ~ Yes S75 comply with the court order, Can the outflow be measured retiab te oe estimate” of P20M. ABC has no other realistic alternative ly? ~ Yes, the problem indicates a Conclusion: A provision must be accrued and disclosed in the amount of 20M. + Note: Before a provision can be recognized, the answer to all the questions in “Steps 1 10 3” must by “yes.” If any has a" js recognized. When a pro 10” for an answer, no provision ion is accrued, a disclosure must also be made. The entry to recognize the provision is as follows: De. | Environmental cleanup costs 20,000,000, 3. 3] Estimated liability for cleanup costs 20,000,000 Illustration 2: Expected value In 20x1, ABC Co. recalled a product due to a possible defect caused by malfunctioning factory equipment. The products recalled will be repaired free of charge. ABC is uncertain whether all products recalled -will have the possible defect. However, the following estimate was made by ABC’s engineers and managerial accountants and approved by the board of directors: Repair cost Probability 20,000,000 5% 15,000,000 20% 10,000,000 35% 5,000,000 40% 100% The expected value of the provision is determined as follows: PP a Scanned with CamScanner166 Chap, Rte "Repair cost Probability — Expected value fa) &) fo) = (a) x). 20,000,000 5% 7,000,000 15,000,000 20% 3,000,000 10,000,000 35% 3,500,000 5,000,000 40% 2,000,000 0% 9,500,000 The entry to recognize the provision is as follows: Dec. | Repair costs 9,500,000 Ty Bu | Estimated liability for repair costs 9.500005 20x 5 Illustration 3: Mid-point In 20x1, a lawsuit was filed against ABC Co. for patent infringement. The plaintiff is claiming P100M in damages. ABC Co.'s legal counsel believes that it is probable that ABC Co. wil lose the lawsuit and pay damages of not less than P10M but net more than P100M. The probability of any amount within the range is as likely as any other amount within that range. The plainiif has offered to settle the lawsuit out of court for P9OM but ABC did not agree to the settlement. What amount of provision is reported in ABC Co.'s 20x1 financial statements? Answer: P35M [(10M + 100M) + 2], i.e., the mid-point of the range. Journal entry: Dee] Probable loss on lawsuit 55,000,000 sal, Estimated liability on pending lawsuit 55,c000e Risk and uncertainties Estimates take into account risks and uncertainties. T* estimates may be increased by a risk adjustment factor to pf" an allowance for imprecision inherent in estimates. This, howe” does not mean that the entity can make excessive provisio"® can deliberately overstate liabilities, at! Scanned with CamScanner167 pe nt value effect of time value of money is material, the estimate of a n is discounted to its present value using a pre-tax te. This is usually the case for provisions for restoration prese! if the rovisio discount FC ni decommissioning, costs where cash outflows occur only after an ety Tong period of time fom the date of iil recognition iiustration 1: Present value | ‘ABC Co. a manufacturer, provides warranties for its products. Under the warranty, ABC Co. undertakes to repair defective roducts within one year from the date of sale. Based on ABC Co’s past experience: 495% of sales require no warranty repairs, while 3% require minor repairs costing 10% of the sale price, and 2% require major repairs costing, 90% of the sale price; + 50% of the estimated repair costs are incurred in the year of sale and 50% are incurred in the following year; and « the appropriate risk adjustment factor to reflect the uncertainties in estimates is an increment of 6% to the probability-weighted expected cash flows. ABC Co. made total sales of P10M in 20x1. On Dec. 31, 20x1, the cash flows for repair costs in 20x2 are expected to occur on June 30, 20x2. The appropriate present value factor is 0.95238. Requirement: Compute for the provision as of Dec. 31, 20x]. Solution: Analysis: ae ic there a present obligation arising from past event? ~ Yes, products have srg Pen sod. The oblgatng event for warranties the act of selling. crea the utfow probable? ~ Yes, ABC Co. expects based on past Step i Ge that there will be claims under the warranties. - = avatay ec IH eww be measured reliably? ~ Yes, sufficient information is Cons make a reliable estimate. sion: A provision must be accrued and disclosed. Scanned with CamScannerMinor repairs (10M x 3% x 10%) 30,09 Major repairs (10M x 2% x 90%) 1805, Total warranty repair costs for the 20x1 i 2inay Multiply by: Portion to be settled in 20x: iy Warranty repair costs not yet paid as of Dec. 31, 20x1 “Wine Multiply by: Risk adjustment (100% + 6%) 10%, Total Tig Multiply by: Present value factor 095% Warranty provision — Dec. 31, 20x1 106,005 Illustration 2.1: Present value ABC Co. is a defendant in a lawsuit, ABC Co.'s lawyers believe that there is a 30% chance that ABC Co. will win the case and pays no damages. However, if ABC Co. loses, there is a 20% chance that it will pay damages of P200,000 (the amount sought by the plaintiff) and an 80% chance that it will pay damages of P100,00) (the amount that was recently awarded by the same judge ina similar case). Other outcomes are unlikely. A 7% risk adjustment factor to the probability-weighted expected cash flows é considered appropriate to reflect the uncertainties in the cash flow estimates. The court decision is expected to be finalized in December 20x2. The appropriate discount rate is 10%. Requirement: Compute for the provision as of Dec. 31, 20x1. Solution: At twenty per cent chance: (200K x 20%) aoa At eighty per cent chance: (100K x 80%) 8000) Total at 100% chance of settlement y20,a00 Multiply by: Probability of settlement (100% me = 30% Probability-weighted expected cash flows 9 se Multiply by: Risk adjustment (100% + 7%) 100 Total D —38 Multiply by: PV of P1 @10%, n=1 0.902 in Provision for pending lawsuit - Dec. 31, 20x1 Scanned with CamScannergent Liabilities and Contingent Assets 10 mission of required disclosure tion 2. ; ss pacts jn Illustration 2.1 above except that in this scenario, ¢ Us of extremely rare circumstances, disclosure of some of the on required by PAS 37 about the case is expected to seriously the position of ABC Co. in the dispute. ause informa prejudice eqrirement: How should ABC Co. account for the lawsuit? nswer? Aveo. recognizes the same amount of provision as computed in fiusration 2.1 but discloses the reason why the required information under PAS 37 has not been disclosed. illustration 2.3: Improbable outflow tse the facts in Ulustration 2.1 above except that in this scenario, ABC Co’s lawyers believe that there is a 60% chance that ABC Co. wwill win the case and incur no outflow. Requirement: How should ABC Co. account for the lawsuit? Step I: Is there a present obligation arising from past event? - Yes, ABC Co. is a defendant in a pending lawsuit. Step 2: Is the outflow probable? —- NO, a 40% chance of occurrence (100% - 60%) isnot probable. Step 3: Can the outflow be measured reliably? — Yes, sufficient information is available to make a reliable estimate. Answer: ABC Co. does not accrue any provision but will disclose only a contingent liability (possible obligation) because wot all the Tecognition criteria are met. Future events one, events may affect the amount needed to settle an provi, on However, future events are considered in estimating * anion OMly if there is objective evidence that supports their Pation. For example, the penalty for an environmental ‘am, eo ®Be may be affected by legislation. If a new Jaw that will re Se Scanned with CamScannerincrease the amount of penalty is expected to be enacted, that nq law is anticipated only when it is virtually certain that it wiy enacted. Otherwise, it would not be appropriate to anticipate Expected disposal of assets Gains from the expected disposal of assets are nof taken in, account when measuring a provision. Gains are recognizes separately when the disposals occur. Reimbursements If another party is expected to reimburse the settlement amount of a provision, a reimbursement asset is recognized if it is virtually certain that the reimbursement will be received. The reimbursement asset is presented in the statement of financial position separately from the provision. However, in the statement of comprehensive income, the expense related to the provision may be presented net of the reimbursement. The amount recognized for the reimbursement should not exceed the amount of the provision. Ilustration 1: Reimbursement ABC Co. is a courier company. During the year, a fire destroyed ABC Co.’s warehouse. ABC Co. estimated that it will probably pay P50M in damages caused to customer-owned goods containe! in the warehouse. The contents of the warehouse were insured: The insurer approved the payment of ABC Co.'s insurance caift of P20M. Journal entries: Dec. 31, | Loss on fire 50,000,000 20x1 Esti Rat ee ont, timated liability on casualty 50,0005 Dec. 31, | Insurance claims receivable 20,000,000 ) 2ox1 Gain on insurance 20,000 . al The reimbursement asset (i.e., the approved insurance ¢™ is recognized separately from the provision. ~ Scanned with CamScannerContingent Liabitities and Coy iiustration 2.1: Deductible clause on January 1, 20x2, an explosion occurred at ABC Co’s plant causing extensive property damage to area buildings. Although no claims had yet been asserted against ABC Co. as of March 10, 20x2, ABC Co.’s management and counsel concluded that it i¢ likely that claims will be asserted and that it is probable that ABC Co. will be held liable for damages. ABC Co.'s P5,000,000 comprehensive public liability policy has a P250,000 deductible clause”. ABC Co. estimates an outflow equal to its net liability on the comprehensive public liability policy. ABC Co’'s financial statements were authorized for issue on March 30, 20%2, 1 A deductible clause is the amount of loss that the insured must first pay before any excess loss is shouldered by the insurance company Requirement: How should ABC Co. report the event above in its December 31, 20x1 financial statements? Answer: As a note disclosure only indicating the probable loss of 250,000 (deductible clause). No provision is recognized because there is no present obligation as of Dec. 31, 20x1, i.e., the explosion occurred in 20x2. Illustration 2.2: Deductible clause What if the explosion in Illustration 2.1 above occurred on December 31, 20x1, how should ABC Co. report the event in its December 31, 20x1 financial statements? Answer: As a provision of ?250,000, i.e., the expected outflow. Changes in pro’ ns Provisions are reviewed at the end of each reporting period and adjusted to reflect the current best estimate. Changes in provisions “te accounted for prospectively by accruing an additional amount ot by reversing a previously recognized amount. When the provision is discounted, the unwinding (mortization) of the related discount, which increases the Srying amount of the provision, is recognized as interest “xpense, Bi Scanned with CamScannerMlustration: Changes in provisions — 20x1: An entity recognizes a provision of P500,000 for Probyy it * loss on a pending lawsuit. Dec. 31, | Probable loss on lawsuit , 500,000 | ~~ 201 | Estimated liability on pending lawsuit Ls 20x2: The lawsuit remains unsettled. The entity reviews it and revises its estimate of loss to P700,009, position on the case Dec. | Probable loss on lawsuit (700K - 500K) 200,000 31, Estimated liability on pending lawsuit 200,00 20x2 20x3 (Scenario 1): The entity settles the lawsuit for P850,000. 20x3 Estimated liability on pending lawsuit Loss on lawsuit Cash. 700,000 150,000 850,000 20x3 (Scenario 2): The entity settles the lawsuit for P600,000. 20x3 | Estimated liability on pending lawsuit | 700,000. Cash one" Gain on settlement of provision 1008 20x3 (Scenario 3): The entity wins the case and pays nothing: 20:3 | Estimated liability on pending lawsuit | 700,000 ¢ Gain on reversal of provision | m0 Use of provisions A provision is used only for the expenditure it was ovisi™® i # intended for. Charging expenditure against a provision id intended for another purpose is inappropriate as it would © the im pact of two different events. Scanned with CamScanner atlntingent Liabilities and Cont eu peo pplication of the recognition and measurement rules puture operating losses no provision is recognized for future operating losses because vy do not meet the definition of a liability (ie, ‘arising from past vents) The expectation of future operating losses may indicate that certain assels may be impaired. Those assets are tested for impairment under PAS 36. Onerous contracts ‘The provision recognized from an onerous contract reflects the reast net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it. Illustration: Onerous contract - Purchase commitment In 20x1, an entity enters into a three-year, non-cancelable purchase contract whereby the entity obtains the right to purchase up to 60,000 units of a product annually for P25 per unit. The entity guarantees a minimum annual purchase of 15,000 units. On Dec. 31, 20x1, the product becomes obsolete. The entity has 10,000 units onhand, which the entity believes can be sold as scrap for P5 each. Requirement: Compute for the loss on purchase commitment to be. Solution: Guaranteed minimum annual purchase (in units) 15,000 Multiply by: Remaining years in the contract (20x2and 203) 2 Total goods to be accepted in the future 30,000 Multiply by: Purchase price less scrap value (P25~?5) 0 °SS on purchase commitment - Dec. 31, 20x1 —800,000_ | Loss on purchase commitment 600,000 Estimated liability on purchase commitment 600,000 joe: Perch Son purchase commitment is recognized only for guaranteed aoe "ropineg eonseently, impairment loss and not “loss on purchase commitment for the 10,000 units on hand on December 31,20x1. a Scanned with CamScannerRestructuring Restructuring is “a progr management, and materially changes © am that is planned and controlled 5 ther: ' a. The scope of a business undertaken by an entity; or ss is conducted.” b. The manner in which that busine: Examples: ‘a. Sale or termination of a line of business; b. Closure of business locations in a country or region or i relocation of business activities from one country or region another; c. Changes in management structure, for example, eliminating , layer of management; and d. Fundamental reorganizations that have a material effect on the nature and focus of the entity’s operations. (ras3770) An entity applies the general recognition criteria provi earlier when recognizing prov addition, considers the following: ns for restructuring costs, and in Sale of operation A legal obligation exists (and therefore a provision is recognize) only if, at the end of the reporting period, a binding sale agrceme! obtained. This is because, until a binding sale agreement § obtained, the entity can still change its mind and may withdrew its plan to sell if it cannot find a purchaser under acceptable tem™* If the binding sale agreement is obtained only after the & of the reporting period, no provision is recognized becau? ™ present obligation exists at the end of the reporting period. ™ however; may be disclosed as a non-adj fer reporting period. justing event aft Closure or Reorganization A constructive obligation exists’ (and therefore a provisio® recognized) only if at the reporting date, the entity has 7°" 7 Scanned with CamScanner175 speaations from others that it will discharge certain valid oh ties. This would be the case if, at the end of the reporting e eon 1h the following conditions are met: sealed formal plan for the restructuring is adopted; and ‘4 “ plan js announced to those affected by it, the b a mere board decision to restructure is not enough. No ision 1S recognized if the detailed plan is adopted or ae need after the end of the reporting period. This may also be jaclosed ‘as a non-adjusting event after reporting period, tasurement of restructuring provision | yesructuring provision includes only the direct costs that are necessarily entailed with the restructuring. It does not include «ests that relate to the ongoing activities of the entity or the future conduct of its business. A restructuring provision excludes the following costs: 2. retraining or relocating continuing staff b, marketing c_ investment in new systems and distribution networks (PAS 37.81) QiSimmary of restructuring provisions: | “Sale of operation | © Accrue a provision only if a binding sale agreement is obtained on or before the end of reporting period. No provision is | recognized if the binding sale | agreement is obtained after the | reporting period. This is only \ disclosed as a non-adjusting event after the reporting period, ‘© Accrue a provision only if a detailed formal plan is adopted | . and announced publicly on or before the end of reporting period, A board decision is not enough. No provision is recognized if the conditions are ib Slsute or reorganization Scanned with CamScanneroe net only after the reporting S period. This would only je disclosed a8 a non-adjustng event after the repo @ Accrue a provision ing employees, ¢ and eliminating product lines only if atinouney at acquisition and, then only, detailed formal plan is adopiy within a short period of time after acquisition (c.., 3 monihy) Provisions are not recognized jg” falure operating losses, evening restructuring. < Restructuring provision on acquisition (merge?) Future operating losses Illustration: Restructuring provision On December 31, 20x1, ABC Co. adopted a detailed formal planty close its toys divisions and put up a new division to manufactur warfare weapons. The plan was communicated through a publi announcement and all those affected by the closure wer informed. ABC Co. estimated the following costs: «Termination benefits of employees terminated as a result of the closure 1.00000 «Costs of retraining and relocating retained employees 2,000 * Payment for the toys division's unpaid purchases one « New systems and distribution networks for the weapons division 20,000.80 + Marketing costs of the weapons division e,o0ne® « . Expected losses in the first year of operations of 1 the weapons division 20,000 Requirement: Compute for the provision on December 31, 20! Answer: 1,000,000 - the termination benefits of em?! terminated as a result of the closure ad, Scanned with CamScannerer On seions, Contingent Linblities and Contingent Assets proisions. i s 177 a restructuring provision does not include costs of retraining, or relocating continuing staff and other costs that relate to the new buicinens Liability for unpaid purchases relate to accounts payable, not provision |) Future operating loss are not included in a toan onerous contract, Provision, unless they relate Journal entry: Employee benefits expense Provision for restructuring costs 1,000,000 1,000,000 Examples of application of the recognition principles 1, An entity engages in transport services. Past experience shows that the entity incurs around P100M a year in car accident lawsuits: Can the entity accrue a year-end provision for car accidents that can happen in the next accounting period? Answer: No. There is no present obligation because there is no accident yet (i.e., no past event yet). During the year, a government regulatory body discovers that ABC Co. has caused environmental damages. The government orders ABC Co. to pay a penalty -of P100M. Should ABC Co. recognize a provision for the environmental damages? Answer: Yes. There is a present obligation because damages have already been caused. The outflow is probable because ABC Co. has no other alternative but to comply with the government order. The Outflow can be measured reliably. [3 Dun * Uuring the year, a government regulatory body noted that the nature of ABC Co.’s production processes may lead to possible damage to the environment. The government recommends that, in order to operate in the particular way, ABC Co. must fit smoke Titers in its factory. The cost of fitting the smoke filters is estimated at P1001 Scanned with CamScanner~~ ha MR ti Answer: No. There is no present obligation because damages hayy yet been caused (ie, ‘may lead to possible damage’) and ABC cg avoid the future expenditure by its future actions, for exampiey" changing the nature of its production proce: q ee | 4. An entity has caused environment damages. Although, curren | there are no laws penalizing such acts, the entity has a Widely | published environmental policy in which it undertakes to reais all environmental damages that it has caused. The entity has; | record of honoring this published policy. The rectification cost can be estimated reliably. Should the entity recognize ; |__ provision? Answer: Yes. There is a present obligation because damages have already been caused. The present obligation arises from « constructive obligation because the entity has created a valid expectation on others that it will rectify damages. The entity hasé record of honoring this expectation; thus, the outflow is probable, and it can be estimated reliably. —e ee ee Fact pattern for next two scenarios: During the year, a mining entity acquired a piece of equipment tof used in extracting mineral resources, The law requires decommissioning (dismantlement) of mining equipment and restoration of the previous installation site at the end of equipment's useful life. Scenrio 1: As of year-end, the equipment was not yet ins Should the entity recognize a provision for the decommission" and restoration costs? - ent Answer: No. There is no present obligation because the equiP™ not yet installed. The obligation to dismantle arises from install? A provision will be recognized only when the equipment is installe _ Scanned with CamScannerscenario 2: It was estimated that of the total decommissio: and restoration costs, 90% pertains to the ret equipment and the restoration of dama; while 10% pertains to the extra equipment was installed ning ‘moval of the ge caused by inst ction of mineral resour: during the year but resources have been extracted. The estimated total decommissioning and restoration costs are P100M, Should the entity recognize a provision, and how much? alling it, ces, The no mineral Answer: Yes. There is a present obligation because the equipment was already installed. The outflow is probable because itis required by law and the outflow can be measured reliably. The provision is measured at P9OM (P100M x 90%), The remaining 10% will be recognized when the mineral resources are extracted. ABC Co, manufactures pharmaceutical products. During the year, a government agency discovered a side-effect caused by a newly introduced product. More than 2,000 patients died with symptoms similar to the discovered side-effect. ABC Co. is the only manufacturer of the product. As of year-end, a lawsuit for P100B has been filed against ABC Co. ABC Co.’s legal counsel believes that ABC Co. will probably lose the case and pay an | _ estimated amount of P80B. Should ABC Co. recognize a provision \__fora loss on the lawsuit? Answer: Yes. All the recognition criteria for a provision are met. ABC Co. should recognize a provision for the estimated amount of P80B. {sa ——————§| |8 ABC Co, manufactures pharmaceutical products. During the Year, after a certain new product was introduced, 2,000 patients did. After a series of investigation, authorities discovered that When the new product is used with another product, the patient Would transform into a gorilla and dies of eating too much bananas. ABC Co’s financial year ends at December 31, 20x1.On ‘arch 31, 20x1, before the financial statements were authorized °r issue, a lawsuit for P100M was filed against ABC Co. | Assuming this is all the information available, should ABC ce Scanned with CamScannerAnswer: No. Although there is present obligation (.e., products have already been sold as of Dec. 31, 20x1 and a lawsuit was filed apaint ABC Co), the problem does not state whether an outflow is propagy and if that outflow can be estimated reliably. Only a note disclosiy, should be made if the obligation is possible. If remote, no disclosun is necessary. ST Sa aa ea’ Fact pattern for next tivo scenarios: On December 15, 20x1, ABC Co. decided to wind up internationg operations in Country B and move them to Country C. The decision was based on a detailed formal plan of restructuring. The restructuring costs were estimated at P1OM. (9, The restructuring plan was announced publicly in December 20x1 | to all employees, customers and other stakeholders in both Country A and Country B. Should ABC Co. recognize a provision s of December 31, 20x1? Answer: Yes. All the recognition criteria are met. By communicating the decision to the affected parties, ABC Co. has created a constructive obligation as of December 31, 20x1 that it will pursue its plan to restructure. | 10. The restructuring plan was conveyed to all workers and | management personnel at the headquarters in Country A during | I December 20x1. Should ABC Co. recognize a provision as of December 31, 20%1? Answer: No. No constructive obligation was created because th decision was not communicated to the affected parties which 2 located in Country B. : : Other common types of provisions The following are also common sources of provisions: a. product warranties and guarantees b. premiums guarantee of indebtedness of others becoming probable _—< Scanned with CamScanner