PROVISION, CONTINGENT LIABILITIES AND CONTINGENT ASSETS – AS- 29

Provision
A provision is a liability which can be measured only by using a substantial degree of estimation:
Contingent liability:
a) A contingent liability is :
b) A possible obligation that arises from past events and existence of which will be
confirmed only by the occurrence or non- occurrence of one or more uncertain future
events
Or
A present obligation that arises from past events but is not recognised because :
a) It is not probable that an outflow of resources will be required to settle the obligation or
b) A reliable estimate of the amount of the obligation cannot be made
Present obligation;
An obligation is a present obligation, if based on the evidence available, its existence at the
balance sheet date is considered probable i.e. more likely than not.
Possible obligation :
Is one, if based on the evidence available, its existence at the balance sheet date is considered
not probable.
Contingent Asset:
Is a possible asset that arises from past events the existence of which will be confirmed only by
the occurrence or non-occurrence of one more uncertain future events.
Recognisation of Provision
Provision should be recognised when all the following conditions are fulfilled:
 An enterprise has a present obligation as a result of past event
 It is probable that an outflow of resources will be required to settle the obligation
 A reliable estimate can be made
If these conditions are not met, no provision should be recognised.
Measurement of Provision;
The amount recognised as a provision should be the best estimate of expenditure required to
settle the present obligation at the balance sheet date.
Recognisation of Contingent liabilities :
An enterprise should not recognise a contingent liability. A Contingent liability is disclosed in the
notes to the accounts unless the possibility of an outflow of resources is remote.
Contingent Assets
Contingent asset arise from unplanned/ unexpected events that give rise to the possibility of an
outflow of economic benefits to the enterprise. An example is a claim that an enterprise is
pursuing through legal process where the outcome is uncertain. An enterprise should not
recognise a contingent asset.
A contingent asset is not disclosed in the financial statements. It is usually disclosed in the
report of the approving authority, where an inflow of economic benefits is possible.
Disclosure Requirements:
For each class of provision, disclose the following :
Carrying amount at the beginning and at the end of the period
Additional provisions and change in estimates during the period
Amounts used during the period
Unused amounts reversed during the period.
Further disclosure, for each class of provision:
Brief description of the nature of the obligation and the expected timing of outflows
Indication of the uncertainties about outflows and major assumptions made concerning future
events
Amount of any expected re-imbursement and amount recognised in respect of that
For each class of contingent liability as at balance sheet date, disclose the following (unless
possibility of outflow is remote)
Brief description of the nature of the contingent liability
Estimate of its financial effect
Indication of the uncertainties relating to any outflow
Possibility of any re-imbursement

Cases And Problems

Problem-1
A manufacturing company gives warranties at the time of sale to purchasers of its product under
the terms of the contract for sale the manufacturer undertakes to make good any manufacturing
defect by repair or replacement provided such defects become apparent within three years from
the date of sale. On past experience, it is probable [more likely than not] that there will be some
claims under the warranties. Comment.
Answer-
 The obliging event is sale of the product with a warranty, which gives rise to an
obligation [ liability]
 As such chances / probability of an outflow of resources exists.
 Therefore a provision should be made.

Problem-2
An enterprise in the oil industry causes contamination but does not clean up because there is no
legislation requiring cleaning up, and the enterprise has been contaminating land for several
years. At 31.3.2009 it is virtually certain that a law requiring a clean up of land already
contaminated will be enacted shortly after the year end. Comment
Answer –
  The obliging event is the contamination of the land and virtual certainty of legislation
requiring its cleaning.
 Outflow of resources- probable.
 Provision should be made for the best estimates of the costs of the clean up.

Problem-3
An enterprise operates an offshore oilfield where its licensing agreement requires it to remove
the oil rig at the end of production and restore the seabed. Ninety per cent of the eventual costs
relate to the removal of the oil rig and restoration of damaged caused by building it, and ten per
cent arise through the extraction of oil. At the balance sheet date, the rig has been constructed
but no oil has been extracted. Comment.
Answer-
 The construction of the oil rig creates an obligation under the terms of the license to
remove the rig and restore the seabed and is thus an obliging event, however no
obligation to rectify the damage that will be caused by extraction of the oil.
 Outflow of resources- probable.
 A provision should be made .

Problem – 4
A retail store has a policy of refunding purchases by the dis-satisfied customers, even though it
is under no legal obligation to do so. Its policy of making refunds is generally known. Comment.
Answer-
 It is a case of present obligation due to past obliging event. Obliging event is the sale of
the product which gives rise to an obligation because obligations also arise from normal
business practice, custom and a desire to maintain good business relations or act in an
equitable manner.
 There is high probability that some goods might be returned.
 Provision should be made for the best estimates of the costs of refunds.

Problem-5
Under new legislation an enterprise is required to fit smoke filters to its factories by 30 th
September 2009. The enterprise has not fixed smoke filters,. Comment
Answer-
Present obligation as a result of a past obliging event- in this case there is no such obligation.
It is not given that Company is polluting the environment. Thus there is no past obliging event.
Thus no present obligation and thence no need to create any provision.
 Problem- 6
The government introduces a number of changes to the income tax system. As a result of these
changes, an enterprise in the financial services sector will need to retrain a large number of its
administrative and sales work force in order to ensure continued compliance with financial
services regulation. At the balance sheet date, no retraining of staff has taken place. Comment.
Answer –
 No past obliging event
 No present obligation
 No provision required.
 At the same time if there are some fines payable for not starting retraining then provision
for such fines should be made.

Problem –7
During 2008-09, an Enterprise „A‟ gives a guarantee of certain borrowings of enterprise „B‟,
whose financial condition at that time is sound. During 2009-10, the financial condition of
Enterprise B deteriorates and at 30th September 2009 it goes into liquidation. Comment.
Answer-
Obliging event is giving of guarantee which creates an obligation but as on 31.3.2009 probability
of outflow is virtually nil and for the same no provision is to be recognised but on 31.3.2010
provision shall have to be created for the best estimates of the obligations.

Problem – 8

There is a income tax demand of Rs.2.5 lakhs against the company relating to prior years
against which the company has gone on appeal to the appellate authority in the department.
The ground of appeal deals with the points covering Rs.1.8 lakhs of the demand. State how the
matter will have to be dealt with in the financial account for the year.
Answer -
A provision of Rs.0.7 lakhs and a contingent liability of Rs. 1.8 lakhs should be provided in the
financial accounts for the year.

Problem- 9 –
A company follows a policy of refunding money to the dis-satisfied customers if they claim within
15 days from the date of purchase and return the goods. It appears from the past experience
that in a month only 0.10% of the customers claims refunds. The company sold goods
amounting to Rs.20 lakhs during the last month of the financial year. Is there any contingency?
Answer -
There is a probable present obligation as a result of past obligating event. The obligating event
is the sale of the product. Provision should be recognized as per AS-29. The best estimate for
provision is Rs. 2,000( Rs.20 lakhs × 0.1%)

Q-10
At the end of the financial year ending on 31.12.2014, a company finds that there are twenty
law suits outstanding which have not been settled till that date of approval of accounts by the
Board of Directors. The possible outcome as estimated by the BOD is as follows.
Probability In % Loss in Rs.
In respect of five cases - Win 100 -
Next 10 cases – Win
Win 60 -
Lose – low damages 30 1,20,000
Lose – high damages 10 2,00,000
Remaining five cases
Win 50 -
Lose – low damages 30 1,00,000
Lose – High damages 20 2,10,000
Outcome of each case is to be taken as a separate entity. Ascertain the amount of contingent
loss and the accounting treatment in respect thereof.
According to As- 29 „ Provisions, Contingent Liabilities and Contingent Assets, contingent
liability should be disclosed in the financial statements if following conditions are satisfied:
 There is a present obligation arising out of past events but not recognised as provision
 It is not probable that an outflow of the resources embodying economic benefits will be
required to settle the obligation
 The possibility of an outflow of resources embodying economic benefits is also remote
 The amount of the obligation cannot be measured with sufficient reliability to be
recognised as provision
In this case, the probability of winning of first five cases is 100% and hence, question of
providing for contingent loss does not arise.
The probability of winning next 10 cases is 60% and for remaining five is 50%. As per AS 29,
we make a provision if the loss is probable. However probability is not there but possibility of
an outflow of resources is not remote either; rather there is reasonable possibility of loss.
Therefore disclosure by way of note should be made. For the purpose of disclosure of
contingent liability by way of note, amount may be calculated as under:
Expected loss in next 10 cases = 30% of Rs. 120,000 + 10% of Rs. 2,00,000 = Rs. 56,000
Expected loss in remaining five cases = 30% of Rs. 1,00,000 + 20% of 2,10,000 = Rs. 72,000

Question – 11
Sun limited has entered into a sale of contract of Rs. 5 crores with X limited during 2014-15
financial year. The profit on this transaction is 1 crore. The delivery of goods is to take place
during the first month of 2015-16. In case of failure of Sun limited to deliver within the schedule,
a compensation of Rs. 1.5 crores is to be paid to X limited. Sun limited planned to manufacture
the goods during the last month of 14-15. As on on the balance sheet date 31.3.15, the goods
were not manufactured and it was unlikely that Sun limited will be in a position to meet the
contractual obligation.
Solution:
According to As- 29 „Provisions, Contingent Liabilities and Contingent Assets, provision should
be made in the financial statements if following conditions are satisfied:
 There is a present obligation arising out of past events but not recognised as provision
 It is probable that an outflow of the resources embodying economic benefits will be
required to settle the obligation
 The possibility of an outflow of resources embodying economic benefits is more likely
than not
 The amount of the obligation can be measured with sufficient reliability to be recognised
as provision
It is probable that Sun limited fail to deliver in time and it is also possible to estimate the amount
of compensation therefore sun limited should provide for contingency amounting to Rs. 1.5
crores as per AS- 29
Amount of provision will be 1.5 crores.

Question – 13
An airline is required by law to overhaul its aircraft once in every three years. A company which
operates aircrafts does-not provide any provision as required by law in its final account. Discuss
with reference to relevant accounting standard.
Answer –
 No past obliging event (it is not given that our crafts are in bad condition so that we
require overhauling right now)
 No present obligation (rather it‟s a future obligation which can be avoided by future
action say by selling the aircrafts).
 No provision required.
 At the same time if there are some fines payable for not starting retraining then provision
for such fines should be made.
 Question – 14
Moon Ltd. Has entered into a Sale Contract of Rs. 6 crores with Y Ltd. during the Financial Year
2012-2013.
The Profit on this Transaction is Rs.1.5 crore. The delivery of goods is to take place during the
first month of financial year 2013-2014. In case of failure of Moon Ltd. to deliver within the
schedule, a compensation of Rs. 1 crores is to be paid to Y Ltd. Moon Ltd. Planned to
manufacture the goods during the last month of the Financial Year 2012-2013. As on Balance
Sheet date 31.03.2012, the goods were not manufactured and it was unlikely that Moon Ltd. will
be in a position to meet the Contractual Obligation.
(i) Should Moon Ltd. Provide for Contingency as per AS-29?
(ii) Should provisions be measured as the excess of compensation to be paid over the profit ?
Solution:
The company has not yet manufactured the product, and hence cannot recognize the sale
transaction as at 31st March 2013. Sale and the resultant profit cannot be recognized unless
and until the product is ready and delivered to the customer. (Assuming transfer in property in
goods takes place at the time of delivery, and not before). It is unlikely that Moon Ltd. Will be in
a position to meet the contractual obligation, and it is more likely to pay the compensation. Such
payment is also quantifiable.
Moon Ltd. should create a provision for the compensation payable, and not just disclose as a
contingent liability, it is an obligation out of a past event. Provision should be measured at the
total compensation and not at the excess over the profit, since profit can be booked only
independently in the next year, upon actual occurrence of the sale transaction.

Question – 15
ZKL Ltd. was under audit for the year ended 31st March. An appeal filed by ZKL Ltd. against the
demand of Excise Duty of Rs.25 crores was pending before the Supreme Court for which
neither provision was made nor was disclosed in the notes to the Financial Statement. On 15th
July (i.e. subsequent to the Balance Sheet date), the Auditor came to know through paper
reports that the point involved in the appeal of ZKL Ltd. was adjudicated by the Supreme Court
in the case of some other assessee, which is in favour of the Department of Excise Duty. The
Auditor insisted that provision be made of Rs 25 crores in the Financial Statements. The
Management was of the view that since its own case is still pending, no provision is called for. It
was also of the view that the event does not have any effect on the financial position of the
Company on the Balance Sheet date. Is the Management‟s view correct?
Solution:
As per AS-29, a provision should be recognized if the following conditions are satisfied –
(i) Present obligation as a result of past event – Excise Duty demand is already made on the
Company.
Hence present obligation exists at the Balance Sheet date.
(ii) Outflow of resources to settle the obligation is probable – Additional evidence arising after
Balance
Sheet date lead to the conclusion that the outflow is probable i.e. more likely than not.
(iii) Reliable estimate of the amount – Rs. 25 crores is the amount of the liability
Since all the conditions for recognition of a provision are satisfied, the Provision should be
recognized for the year ending 31st March. If the amount is material, separate disclosure is also
required. The Management‟s contention is not tenable.

Question – 16
Nature Ltd. was involved in wage negotiation with trade unions of their organization as on 31st
March 2013. Wage revision proposals could be finalized only after obtaining the final approval
from the Head Office of the Company located at Chennai. The final approval was granted on
15th April 2013 w.e.f. 1st April 2011. The settlement covered period from 01.04.2011 to
31.03.2013. the liability upto 31st March 2013 was disclosed on account of the above settlement
in the notes forming part of the Accounts. As an Auditor, you may advise whether such
disclosure is proper.
Solution:
As per AS-29, a provision should be recognized if the following conditions are satisfied –
(i) Present obligation as a result of past event – Wage revision is for the period covered by
Financial
Statements, i.e. 2012-2013, and consists of the Company‟s present obligation.
(ii) Outflow of resources to settle the obligation is probable – Post Balance Sheet date events
(i.e. sanction from H.O.) that the payment of revised wages is probable, i.e. more likely than not.
(iii) Reliable estimate of the amount – Though not quantified in the question, wage payable on
the revised scale can be estimated reliably.
Since all the conditions for recognition of a provision are satisfied, the Provision should be
recognized for the year ending 31st March 2013. Also, under AS-5, when items of Income and
Expenses within Profit. Loss from ordinary activities are of such size, nature or incidence, that
their disclosure is relevant to explain the performance of the Enterprise for the period, they
should be disclosed separately. Since the company has only disclosed the fact and not created
any provision, the treatment given by the company is not correct.

Question – 17
Prakrati Ltd. is in the process of finalizing its Accounts for the year ended 31st March 2013. The
company seeks your advice on the following :
(i) The Company‟s Sales Tax Assessment for the A.Y. 2010-2011 has been completed on 10th
February 2013 with a demand of Rs. 2 crores. The company paid the entire due under protest
without prejudice to its right of appeal. The company files its appeal before the Appellate
Authority wherein the grounds of appeal cover Tax on additions made in the Assessment Order
for a Sum of Rs. 1.75 crore.
(ii) The company has entered into a Wage Agreement in April 2013 whereby Labour Union has
accepted a revision in wage from July 2012. The agreement provided that the hike till April 2013
will not be paid to the employees but will be settled to them at the time of retirement. The
company agrees to deposit the arrears in Government Bonds by September 2013.
Solution:
Since the company is not appealing against the addition of Rs. 0.25 crores, the same should be
provided for in its Accounts for the year ended on 31st March 2013. The amount paid under
protest can be kept under the head “Loans and Advances” and disclosed along with the
contingent liability of ` 1.75 crores.
The arrears for the period from July 2012 to March 2013 are required to be provided for in the
Accounts of Company for the year ended on 31st March 2013.

Question – 18
TWK Ltd. Has not included in the Balance Sheet as on 31.03.2012, a sum of Rs. 1.20 crores
being amount in the arrears of salaries and wages payable to the staff for the last 2 years as a
result of successful negotiation which were going on during the last 18 months and concluded
on 30.04.2012. The Auditor wants to sign the said Balance Sheet and give the audit report on
31.05.2012. The auditor came to know the result of the negotiation on 15.05.2012.
Solution:
The obligation requires a provision for outstanding expenses under AS-29. The facts have
become known to the Auditor before the date of issue of the Audit report and before the date the
Financial Statements are issued, under SA-560. The Auditor should request the Management to
create provision for Rs.1.20 crores. If not done, he should qualify his Audit Report.

Question – 19
Bontex India Ltd. Took a factory premises on lease on 01.04.2010 for Rs. 2,50,000 per month.
The lease is operating lease. During March 2011, Bontex India Ltd. relocates its operation to a
new factory building. The lease on the factory premises continues to be live upto 31.12.2013.
The Lease cannot be cancelled and cannot be sub-let to another user. The auditor insists that
lease rent of balance 33 months upto 31.12.2013 should be provided in the accounts for the
year ending 31.03.2011. Bontex India Ltd. Seeks your advice.
Solution:
“Onerous Contract” is a contract in which the unavoidable costs of meeting the obligation under
the contract exceeds the economic benefits expected to be received under it.
In the given case, the Operating Lease Contract has become onerous, as the economic benefit
of lease contract for next 33 months up to 31.12.2013 will be nil. However, the Lessee, Bontex
India Ltd. has to pay lease rent of 82,50,000 (i.e. 2,50,000 p.m. for next 33 months). Therefore,
provision on account of 82,50,000 is to be made in the accounts for the year ending
31.03.2011, in accordance with AS-29 requirements.

Question -20
An asset does not meet the requirements of environment laws which have been recently
enacted. The asset has to be destroyed as per the law. The asset is carried in the Balance
Sheet at the year end at Rs. 5,00,000. The estimated cost of destroying the asset is Rs. 50,000.
How is the asset to be accounted for?
Solution:
Fixed assets should be eliminated from the Financial Statements on disposal, or when no
further benefit is expected from its use or disposal. So, the fixed asset should be eliminated
from the Financial Statements, as it is proposed to be destroyed as per law.
Cost of destroying the asset of Rs. 50,000 should be accounted for as and when incurred. A
provision for the same should not be created since it is an obligation from a future event i.e.
destruction of the asset.)

Question -21
A public interest Litigation (PIL) has been filed before Supreme Court on the environmental
influences of air, noise and water pollution caused by certain manufacturing industries. The
matter has been heard by the court and proceedings show that the court will direct such
industries to install suitable pollution control equipments. However, till the date the accounts
have been approved by the Board of Directors of a company, no such order has come from the
court. The company feels that no provisioning or disclosure is required as the Court order has
not been served on the company. Is this justifiable?
Solution:
As per AS – 29 a provision should be recognized if the following conditions are satisfied:
Condition (1) -Present obligation as a result of past event.- environment pollution and filling of
PIL thereon is the past event on account of which there is present obligation
Condition (2) -Outflow of resources to settle the obligation is probable- cost of installation of
pollution control equipments is probable
Condition (3) - Reliable estimate of the amount- can be made
Obligation event is the pollution caused, because of the virtual certainty that the Supreme court
will direct such industries to install suitable pollution control equipments.
Treatment and Conclusion: Since all the conditions for recognition of provision are satisfied, a
provision should be recognized for the above financial year. The company‟s contention not to
make any provision or disclosure, violates AS-29 requirements.
 Question - 22
Wise ltd. had made an appeal before the Income Tax Appellate Tribunal on its Income Tax
Assessment. The case was lost and accordingly a demand notice for Rs. 25 lakhs was received
towards the Company‟s tax liability. The company has however, preferred an appeal in High
Court before the end of the financial year, which is pending as on the Balance Sheet Date and
also till the approval of Financial Statements by their Board of Directors. The Company has not
provided for the liability and also feels that no disclosure is required comment.
Solution:
As per AS – 29 a provision should be recognized if the following conditions are satisfied:
Condition (1) -Present obligation as a result of past event.
Condition (2) -Outflow of resources to settle the obligation is probable.
Condition (3) - Reliable estimate of the amount
Liability for income tax existed on the balance sheet date, as per the Tribunal order. There is a
present obligation.
There will be Outflow of resources settle the obligation, if the company does not win the case
in High Court.
Tax Liability is ascertained at Rs. 25 lakhs, as per the Demand Notice.
Note: Merely because an appeal has been made before the Higher appellate authorities, the
character of the obligation is not lost.
Treatment and Conclusion: Since all the conditions for recognition of provision are satisfied, a
provision for tax Liability Rs. 25 should be recognized for the above financial year. The
company‟s contention not to make any provision or disclosure, violates AS-29 requirements.