IA -2 Provision, Contingent

Liability

Presented by: Renato O. Daquioag CPA, MBA, CFC.

IA -2 Provision, Contingent Liability

Technical Knowledge

 To understand the nature of a provision.

 To know the condition for the recognition of a
provision.
 To know the measurement of a provision
 To identify measurement consideration for a
provision.
 To know the requirements for the recognition of
contingent liability and contingent assets
PROVISION

A Provision is an existing liability of uncertain timing or

uncertain amount. The essence of provision is that there is
uncertainty about timing of the expenditures.

The liability definitely exists at the end of reporting period but

the amount is indefinite or the date when the obligation is due is
also indefinite, in some cases, the payee cannot be identified or
determined.

Actually, a provision maybe the equivalent of an estimated

liability or a loss contingency that is accrued because it is both
probable and measurable
RECOGNITION OF PROVISION

PAS 37, paragraph 14, provides that provision shall be recognized as

a liability in the financial statements under the following conditions.

a. The entity has a present obligation, legal or constructive, as a

result of past event.
b. It Is probable that an outflow of resources embodying economic
benefits would be required to settle the obligation.
c. The amount of the obligation can be measured reliably.

Obligating Event – is an event that creates a legal or constructive

obligation because the entity has no realistic alternative but to settle
the obligation created by the event.
Probable outflow of economic benefits

For a provision to qualify for recognition there must be not only a

present obligation but also a probable outflow of resource embodying
economic benefits to settle the obligation.

An outflow of resources is regarded as probable if the event is more

likely than not to occur, meaning, the probability that the event will
occur is greater than the probability that it will not occur.

Rule of thumb,

Probable – means more than 50% likely or substantially more

Possible – means 50% or less likely to occur
Remote – means 10% or less likely to occur or very slightly to
occurrence
Measurement of Provision

The amount recognized as provision should be the BEST ESTIMATE.

Of the expenditure required to settle the present obligation at the end of
reporting period.

Best estimate is the amount that the entity would rationally pay to settle
the obligation at the end of reporting period or to transfer it to a third party
at that time.

Where there is continuous range of possible outcomes and each point in

that range is as likely as any other the midpoint of the range is used

Where the provision being measured involves a large population of items,

the obligation is estimated by “weighting “ all possible outcomes by their
possibilities. The name for the statistical method of estimation is
“expected value”
Other Measurement Considerations

The following items are taken into consideration in recognizing and

measuring a provision:

1. Risks and Uncertainties.

2. Present value of obligation.
3. Future Events
4. Expected Disposal of assets
5. Reimbursements
6. Change in provision
7. Use of provision
8. Future operating losses
9. Onerous contract
Example of Provision

1. Warranties
2. Environmental Contamination
3. Decommissioning or abandonment costs
4. Court Case
5. Gauranteee
Restructuring

PAS 37, paragraph 10, defines restructuring as a “program that is planned

and controlled by management and materially changes either the scope of
a business of an entity or the manner in which that business is conducted”.

Events that may qualify as restructuring include:

a. Sale or Termination of a line of business

b. Closure of business location in a region or relocation of business
activities from one location to another or relocation of headquarters
from one country to another.
c. Change in management structure, such as elimination of a layer of
management or making all functional units autonomous.
d. Fundamental reorganization of an entity that has a material and
significant impact on its operations.
Provision for restructuring
Recognition of the provision for restructuring is required because a
constructive obligation may arise from the decision to restructure.

A constructive obligation for restructuring arises when two condition are

presents:

1. The entity has a detailed formal plan for the restructuring which
includes the following:
a. The business being restructured.
b. The principal location affected
c. The location, function and approximate number of employees
who will be compensated for terminating their employment
d. Date when the plan will be implemented
e. The expenditures that will be undertaken.
2. The entity has raised valid expectation in the minds of those affected
that the entity will carry out the restructuring by starting to implement
the plan and announcing the main features to those affected by it.
Provision for restructuring
PAS 37, paragraph 81, specifically excludes the following expenditures
from the restructuring provision:

a. Cost of retraining or relocating continuing staff.

b. Marketing or advertising program to promote the new company image.
c. Investment in new system and distribution network.
Contingent Liability
PAS 37, paragraph 10, defines a contingent liability in two ways.

A contingent liability is a possible obligation that arises from past event

and whose existence will be confirmed only by the occurrence or
nonoccurrence of one or more uncertain future events not wholly within
the control of the entity.

A contingent Liability is a present obligation that arises from past event

but is not recognized because it is not probable that an outflow of resource
embodying economic benefits will be required to settle the obligation or
the amount of the obligation cannot be measured reliably.
Contingent asset
PAS 37, paragraph 10, defines the following definition:

A Contingent asset is a possible assets that arise from past event and
whose existence will be confirmed only by the occurrence or
nonoccurrence of one or more uncertain future events not wholly within
the control of the entity.

A contingent asset shall not be recognized because this may result to

recognition of income that may never be realized.

However, when the realization of income is virtually certain, the related

assets is no longer contingent assets and its recognition is appropriate.
Decommissioning Liability
A decommissioning liability is an obligation to dismantle, remove and
restore, an item of property, plant and equipment as required by law or
contract.

A decommissioning liability is also called asset retirement obligation.

Change in Decommissioning Liability

Under IFRIC 1, changes in the measurement of an existing

decommissioning liability shall be accounted for as follows:

1. A decrease in the liability is deducted from the cost of assets

2. An increase in liability is added to the cost at the assets.
APPLICATION OF CONCEPT: