Chapter 11

Provisions, Contingent
Liabilities and
Contingent Assets
Prepared by
Kent Wilson

Adapted & Adjusted from Sources:

Picker, R. Leo, K.J, Loftus, J. Wise, V., Clark, K., and Alfredson, K., (2012).
Applying International Financial Reporting Standards, 3rd Edition, John Wiley
& Sons Inc. , USA.

Kieso, D.E., Weygandt, J. J., Warfield, T.D. (2015). Intermediate Accounting ,

IFRS 2nd Edition, John Wiley & Sons Inc., USA

IAS 37, MFRS137

 Objectives
1. Describe the background of IAS 37/MFRS 137

2. Outline the concept of a provision and how it differs from other

liabilities

3. Identify recognition and measurement criteria for provisions

4. Outline the concept of a contingent liability and how it differs from a

provision

5. Outline the concept of a contingent asset

6. Describe the disclosure requirements of IAS 37/MFRS 137

 Introduction to IAS 37/MFRS 137

• MFRS 137 is equivalent to IAS 37 Provisions, Contingent Liabilities and

Contingent Assets as issued and amended by the IASB, including the effective
and issuance dates. Entities that comply with MFRS 137 will simultaneously be
in compliance with IAS 37.

• IAS 37 addresses the recognition, measurement and presentation of:

– Provisions
– Contingent assets and liabilities
 (A) Provision
• Liability (as defined in Conceptual Framework) is:
– a present obligation
– arising from a past event
– that is expected to result in an outflow of economic
resources
• A provision is a subset of liabilities, defined in IAS
37/MFRS 137 as:
- a liability of uncertain timing or amount.
• Provision also called estimated liability.
 Distinguishing Provisions From Other
Liabilities
• Key distinguishing factor is the uncertainty
relating to either the timing or the amount

• Typical provisions :
– Warranty
– Premiums and Coupons
– Environmental
– Restructuring
 Recognition Criteria For Provisions
• Three criteria:
1. Present obligation(legal or constructive*) as a result of
a past event
2. Probable** outflow of resources to settle
3. Amount of obligation can be reliably estimated

If these 3 criteria are not met, no provision is recognized.

Recognition Criteria For Provisions
*Constructive obligation: obligation that derives from
a company’s action where:
a. By an established pattern of past practice, published
policies or a sufficiently specific current statement,
the company has indicated to other parties that it will
accept certain responsibilities; and
b. As a result, the company created a valid expectation
on the part of those other parties that it will discharge
those responsibilities.
** Probable: more likely than not to occur which also
means that probability of occurring is greater than 50%.
Decision Tree
 Recognition
Recognition of
of aa Provision
Provision

Recognition Examples
Illustration 13-4

9LO 4
 Recognition
Recognition of
of aa Provision
Provision

Recognition Examples
Illustration 13-5

10LO 4
 Measurement of Provisions

• “Best estimate” of provision amount recognised

– Requires professional judgements (based on past/similar
transaction, discuss with expert, any other pertinent
information)
– Is calculated using ‘expected value’ estimation
– Measured before tax

• Estimates should be discounted to present value

where material
 Measurement of Provisions

• Should account for expected cash outflows only,

disregarding any expected cash inflows (refer Picker
et al. Page 147)

• Must review provisions at each end of reporting

period
 Measurement
Measurement of
of Provisions
Provisions

Measurement Examples
Management must use judgment, based on past or similar
transactions, discussions with experts, and any other pertinent
information.

Toyota warranties. Toyota might determine that 80

percent of its cars will not have any warranty cost, 12 percent will
have substantial costs, and 8 percent will have a much smaller cost.
In this case, by weighting all the possible outcomes by their
associated probabilities, Toyota arrives at an expected value for its
warranty liability.
 Common
Common Types
Types of
of Provisions
Provisions

(a) Warranty Provisions

Promise made by a seller to a buyer to make good on a deficiency
of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims and a

company can reasonably estimate the costs involved, the
company must record an expense.
 Common
Common Types
Types of
ofProvisions
Provisions
Warranty Provisions

• Given by manufacturers to buyers.

• Under the contract, a company undertakes to make good,
by repair or replacement, product defects that become
apparent within a stated period after the date of sale.
• The normal warranty period is one or two years (however it
can be more).
• Provisions for the cost of repair or replacement are
recognized as a liability.
• Matching principle: warranty expenses shall be recorded in
the period the products are sold although the actual cost of
repair or replacement occurs in the following period(s).
• Therefore, companies have to estimate the amount of
expenses and provisions on the balance sheet date.
• However, if the amount cannot be determined reliably or is
not material, no obligation is recorded.
 Common
Common Types
Types of
of Provisions
Provisions
Warranty Provisions
Example: Streep Factory provides a 2-year warranty with one of its
products which was first sold in 2010. In that year, Streep spent
$70,000 servicing warranty claims. At year-end, Streep estimates that
an additional $400,000 will be spent in the future to service warranty
claims related to 2010 sales. Prepare Streep’s journal entry to record
the $70,000 expenditure, and the December 31 adjusting entry.

2010 Warranty expense 70,000

Cash 70,000
12/31/10 Warranty expense 400,000
Warranty liability 400,000
 Common
Common Types
Types of
of Provisions
Provisions

(b) Premiums and Coupons (Consideration Payable )

Companies should charge the costs of premiums and coupons
to expense in the period of the sale that benefits from the plan.

Accounting:
 Estimate the number of outstanding premium offers that
customers will present for redemption.
 Charge cost of premium offers to Premium Expense and
credits Premium Liability.
 Common
Common Types
Types of
of Provisions
Provisions
Premiums and Coupons
Illustration: Fluffy Cake Mix Ltd sells boxes of cake mix for £3 per
box. In addition, Fluffy Cake Mix offers its customers a large durable
mixing bowl in exchange for £1 and 10 box tops. The mixing bowl
costs Fluffy Cake Mix £2, and the company estimates that customers
will redeem 60% of the box tops. The premium offer began in June
2019. During 2019, Fluffy Cake Mix purchased 20,000 mixing bowls
at £2, sold 300,000 boxes of cake mix for £3 per box, and redeemed
60,000 box tops.
 Common
Common Types
Types of
of Provisions
Provisions
Premiums and Coupons
Illustration: The entry to record sales of 300,000 boxes of cake mix would
be:
Cash (£3 x 300,000) 900,000
Sales revenue 900,000

To record purchase of 20,000 mixing bowls at £2 per bowl in 2019:

Inventory of premiums 40,000
Cash (£2 x 20,000) 40,000

To record the actual redemption of 60,000 box tops, the receipt of £1 per 10
box tops, and the delivery of the mixing bowls:
Cash [(60,000/10) x £1] 6,000
Premium Expense 6,000
Inventory of premiums [(60,000/10) x £2] 12,000
 Common
Common Types
Types of
of Provisions
Provisions
Premiums and Coupons
The adjusting entry to record additional premium expense and the
estimated premium liability at 31 December 2019 is as follows:

Premium Expense 12,000

Premium Liability 12,000*

*
Total box tops sold in 2019 300,000
Estimated redemptions (in percent) 60%
Total estimated redemptions 180,000
Cost of estimated redemptions
(180,000 box tops/ x (£2 - £1) £18,000
Redemptions to date (£6,000)
Liability at 31 December 2019 £12,000
20
 Common
Common Types
Types of
of Provisions
Provisions
Premiums and Coupons

In the financial statement of Fluffy Cake Mix Ltd as at

31/12/2019:
Current asset:
Premium inventory £28,000 (£40,000-£12,000)
Current liability:
Premium liability £12,000 (£18,000- £6,000)

In the Income Statement of Fluffy Cake Mix Ltd for the

year ended 31/12/2019:
Selling expense:
Premium expense £18,000 (£12,000+ £6,000)
 Common
Common Types
Types of
of Provisions
Provisions
Environmental Provisions

A company must recognize an environmental liability

when it has an existing legal obligation associated with the
retirement of a long-lived asset and when it can reasonably
estimate the amount of the liability.

22
 Common
Common Types
Types of
of Provisions
Provisions
Environmental Provisions

Examples of Obligating Events involving environment provisions

(require recognition of a liability) include, but are not limited to:
► Decommissioning nuclear facilities,
► Dismantling, restoring, and reclamation of oil and gas properties,
► Certain closure, reclamation, and removal costs of mining
facilities,
► Closure and post-closure costs of landfills.

23
 Common
Common Types
Types of
of Provisions
Provisions
Environmental Provisions
Measurement. A company initially measures an environmental
liability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental liability

a company includes
► the cost associated with the environmental liability in the
carrying amount of the related long-lived asset, and
► records a liability for the same amount.

24
 Common
Common Types
Types of
of Provisions
Provisions

Environmental Provisions
Illustration: On January 1, 2010, Wildcat Oil Company erected an
oil platform in the Gulf of Mexico. Wildcat is legally required to
dismantle and remove the platform at the end of its useful life,
estimated to be five years. Wildcat estimates that dismantling and
removal will cost $1,000,000. Based on a 10 percent discount rate,
the fair value of the environmental liability is estimated to be
$620,920 ($1,000,000 x .62092). Wildcat records this liability on Jan.
1, 2011 as follows.

Drilling platform 620,920

Environmental liability 620,920

25
 Common
Common Types
Types of
of Provisions
Provisions

Environmental Provisions
Illustration: During the life of the asset, Wildcat allocates the asset
retirement cost to expense. Using the straight-line method, Wildcat
makes the following entries to record this expense.

December 31, 2011, 2012, 2013, 2014, 2015

Depreciation expense ($620,920 / 5) 124,184

Accumulated depreciation 124,184

26
 Common
Common Types
Types of
of Provisions
Provisions

Environmental Provisions
Illustration: In addition, Wildcat must accrue interest expense each
period. Wildcat records interest expense and the related increase in
the environmental liability on December 31, 2011, as follows.

December 31, 2011

Interest expense ($620,092 x 10%) 62,092
Environmental liability 62,092

27
 Common
Common Types
Types of
of Provisions
Provisions

Environmental Provisions
Illustration: On January 10, 2016, Wildcat contracts with Rig
Reclaimers, Inc. to dismantle the platform at a contract price of
$995,000. Wildcat makes the following journal entry to
record settlement of the liability.
January 10, 2016

Environmental liability 1,000,000

Gain on settlement of liability 5,000
Cash 995,000

28
 Common
Common Types
Types of
of Provisions
Provisions

Restructuring provisions

• The most controversial aspect of IAS 37/MFRS 137

• Restructuring provisions can be recognised as part

of an acquisition of another business (IFRS 3)

• IAS 37/MFRS 137 addresses non business

combination restructuring
 Common
Common Types
Types of
of Provisions
Provisions
Restructuring is “a program that is planned and controlled by
management and materially changes either the (1) scope of a
business undertaken by the company; or (2) the manner in
which that business is conducted.”

Examples of restructuring:
• Sale or termination of a line of business
• The closure of business locations in a country region or relocation of
business activities
• Changes in the management structure
• Fundamental reorganisations

Accounting standards is very restrictive regarding (1) when and (2) types
of costs that can be included in the restructuring provisions.
 Common
Common Types
Types of
of Provisions
Provisions
Essential conditions to recognise a restructuring provision:

(a) Must have a present obligation to restructure

Present obligation is considered to arise when the entity has a detailed plan identifying at
least:

- The business (or part thereof) concerned

- The locations affected
- The employees affected
- The expenditures that will be undertaken
- The timing of implementation

Must have raised a valid expectation by those affected that it will carry out the
plan by commencing restructuring or making an announcement to those affected.

In the case of restructuring provisions arising as part of an acquisition of

another business, the provisions must be recognised in the books of the acquiree
 Common
Common Types
Types of
of Provisions
Provisions

(b) Costs must be directly and necessarily caused by the

restructuring
• Examples of direct cost: employee termination costs related directly to
the restructuring, contract termination costs such as lease termination
penalties, costs associated with employees dismantling plant etc.
• Examples of indirect cost (that cannot be included): investment in new
system, lower utilization of facilities, costs of training or relocating
staff, cost of moving assets or operations, marketing costs etc. These
costs are excluded because they are relate to the future operations of
the business and are not liabilities associated with the restructuring.

(c) If the restructuring involves the sale of an

operation, a binding sale agreement is needed
 (B) Contingent Liabilities and
Contingent assets
Contingent liabilities are either:

(a) A possible obligation whose existence will be

confirmed only by the occurrence or non-
occurrence of one or more uncertain future
events not wholly in control of the entity
eg. a guarantee on a loan for another entity

OR…
 Contingent Liabilities
(b) A present obligation that fails the recognition criteria because:
• it is not probable an outflow of resources will be required to settle the
obligation or
• the amount cannot be measured reliably
eg. a law suit where amount of damages is uncertain

• Contingent liabilities are not recognised in the financial statements but must be
disclosed in the notes to the financial statements. It is because they are:
(1) a possible obligation (not yet confirmed as a present obligation),
(2) a present obligation for which it is not probable that payment will be
made; or
(3) a present obligation for which a reliable estimate of the obligation cannot
be made.
 Contingent Liabilities
Example:
 A lawsuit in which it is only possible that the company might
lose.
 A guarantee related to collectability of a receivable.
Companies should disclose the CL in the notes unless the
possibility of any outflow in settlement is remote.
Outcome Probability* Accounting treatment
Virtually certain At least 90% Report as liability
(provision)
Probable 51-89% Report as liability
(provision)
Possible but not probable 5-50% Disclosure required
Remote Less than 5% No disclosure required
 Contingent Assets

• Possible asset arising from a past event whose existence

will be confirmed by the occurrence/non-occurrence of one
or more uncertain future events not within the control of
the entity.

• Contingent assets are:

1. Possible receipts of monies from gifts, donations and
bonuses.
2. Possible refunds from the government in tax disputes.
3. Pending court cases with a probable favorable
outcome.
 Contingent Assets
• Contingent assets are not recognised in the statement of
financial position but must be disclosed in the notes to the
financial statements where an inflow of benefits is probable.

Outcome Probability Accounting treatment

Virtually certain Ta least 90% probable Report as asset (no longer
contingent)
Probable (more likely than 51-90% probable Disclose
not)
Possible but not probable 5-50% No disclosure required
Remote Less than 5% No disclosure required
 Disclosure

• IAS 37/MFRS 137 paras 84- 92 outline the disclosure

requirements
– Disclosure for each class of provision required
– Disclosure for each class of contingent liability required
– Disclosure of nature of contingent assets
– Exemptions permitted in rare cases (para 92)

• Many analysts consider the contingent liabilities note to be one

of the most important
 Expected Future Developments
• IASB issued exposure draft in 2005 proposing
significant changes:
– Title of standard
– New definitions of contingencies
– New recognition and measurement criteria

• The proposed changes are far reaching and have

attracted widespread concern