Chapter 7 Accounting for Provisions, Contingencies and Events after the Reporting Period

1.
1.1 1.2 1.3 1.& 1.*

Objectives
Define and identify provisions ( ), contingent liabilities ( ) and contingent assets () (HKAS 37). !plain t"e re#$ire%ents of HKAS 37 in relation to t"e acco$nting treat%ent of contingencies in t"e financial state%ents and t"eir disclos$res. Define events after t"e reporting period. 'dentify ad($sting and non)ad($sting events after t"e reporting period. !plain t"e re#$ire%ents of HKAS 1+ in relation to acco$nting for events after t"e reporting period and t"eir disclos$res.

H K A S 1+

H K A S 37

A d ($ s tin g v e n ts

, o n )a d ($ s tin g v e n ts

'n tro d $ c tio n

- e c o g n itio n D is c lo s $ re s 0 eas$ re% ent

. " a n g e s in / ro v is io n s

A p p l i c a ti o n o f t " e - $ l e s t o S p e c i f ic . irc $ % s ta n c e s

D is c lo s $ r e s

2.

Provisions
,7)1

(A) 2.1

The nature of provisions Definitions Provisions are liabilities for which the a%o$nt or ti%ing of the expenditure that will be undertaken is $ncertain ( ).

2.2

2.3

't believes t"at provisions are a sub class of liabilities and not a separate ele%ent of t"e state%ent of financial position. Provisions are distinguished from other liabilities by the uncertainties involved. 1"is definition is significant beca$se it %eans t"at provisions must also meet the definition of liabilities, i.e., there must be an obligation to transfer economic benefits. 1"e reasoning be"ind t"e %ain re#$ire%ents in HKAS 37 is t"at recogni2ing a provision for ite%s t"at are not liabilities 3o$ld a%o$nt to bias rat"er t"an pr$dence and 3o$ld i%pair t"e $sef$lness of t"e financial state%ents. Example 1rade payables are liabilities to pay for goods t"at "ave been s$pplied4 "o3ever, trade payables are not provision. 1"e ter%s and conditions, incl$ding price and delivery of goods "ave been for%ally agreed 3it" t"e s$pplier at t"e ti%e of placing order 3it" t"e s$pplier. 1"ere s"o$ld "ave s$fficient certainty regarding t"e a%o$nt and ti%ing of settle%ent for t"is transaction.

2.&

2.*

Exercise !plain 3"y accr$als for electricity are liability b$t not provisions. !olution"

(#)

$b%ective of &'A! ()
,7)2

2.5

$b%ective 1"e ob(ective of HKAS 37 is to ens$re t"at6 (a) appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets4 (b) sufficient information is disclosed in the notes to t"e financial state%ents to enable $sers to understand their nature* timing and amount.

(+) 2.7

,ecognition ,ecognition +riteria A provision s"o$ld be recogni-ed 3"en6 (i) an enterprise "as a present obligation (legal or constr$ctive) as a res$lt of a past event ( )4 (ii) it is probable t"at an outflow of resources e%bodying econo%ic benefits 3ill be re#$ired to settle the obligation (!"# $%&'()* +,-./)4 and (iii) a reliable estimate can be %ade of t"e a%o$nt of t"e obligation (# $0$12).

(a) 2.7

First criterion present obligation as a result of a past event 1"e present obligation %ay be6 (i) a legal obligation (3 ), or (ii) constructive obligation ( ), 3"ere e!ist 3"en t"e enterprise "as no realistic alternative to settling t"e obligation created by t"e event.

2.8

Definitions (a) A legal obligation is an obligation t"at arises from a contract (t"ro$g" its e!plicit or i%plicit ter%), legislation or other operation of law, and t"e obligation arises only 3"en t"e legislation is virt$ally certain to be enacted as drafted.
,7)3

(b)

(c)

A present obligation arising ot"er t"an fro% a contract, legislation or ot"er operation of t"e la3 is called a constr$ctive obligation. S$c" obligation arises from an enterprise.s actions only , for e!a%ple, by an established pattern of past practice or published policies . 1"e enterprise "as indicated to ot"er parties t"at it 3ill accept certain responsibilities, as a res$lt, t"e enterprise "as created a valid expectation on t"e part of t"ose ot"er parties (e.g. c$sto%ers, s$ppliers, e%ployees) t"at it 3ill disc"arge t"ose responsibilities. 1"e past event that leads to a present obligation is called an obligating event ( 456 ), i.e., it creates a legal or constr$ctive obligation t"at res$lts in an enterprise "aving no realistic alternative to settling that obligation. 9nly t"ose obligations arising fro% past events e!isting independently of an enterprise:s f$t$re actions t"at are recogni2ed as provisions.

2.1+

9n t"e ot"er "and, if t"e enterprise can avoid the future outflow of resources e%bodying econo%ic benefits by its future actions, no obligating event exists and t"$s no provision should be recogni-ed. 'n t"e past, so%e enterprises "ave recogni2ed provisions i%%ediately t"at t"e need for a progra%%e of e!pendit$re "as been identified, based on gro$nds of pr$dence. Example / 0 $verhaul costs (obligating events does not exist) '; Air3ays is re#$ired $nder t"e legislation of .o$ntry - to over"a$l its aircraft once every t"ree years. 1o provision for t"e over"a$l costs s"o$ld be recogni2ed. ven a legal re#$ire%ent to over"a$l does not %a<e t"e costs of over"a$l a liability, beca$se no obligation e!ists to over"a$l t"e aircraft independently of t"e enterprise:s f$t$re actions. 1"e over"a$l e!pendit$re can be avoided by 23 Airways. future actions, say by selling t"e aircraft, so t"ere is no present obligation for t"e f$t$re e!pendit$re.

2.11

2.12

Example ( 0 +ontaminated land (legal obligation) A= >td is an oil e!tracting co%pany. 't "as been conta%inating land in .o$ntry ? for several years, b$t t"ere "as "ad no legislation in .o$ntry ? re#$iring cleaning $p. At 31 Dece%ber 2+1+ it is virt$ally certain t"at a draft la3 re#$iring a clean)$p of land already conta%inated 3ill be
,7)&

enacted s"ortly after year)end. Present obligation as a result of a past obligating event @ 1"e obligating event is t"e conta%ination ( 7 8 ) of t"e land beca$se of t"e virt$al certainty of legislation re#$iring cleaning $p. An outflow of resources embodying economic benefits in settlement @ /robable. +onclusion @ A provision is recognised for t"e best esti%ate of t"e costs of t"e clean)$p. 2.13 Exercise / 0 +ontaminated land (constructive obligation) .D >td. is in t"e oil ind$stry. 't operates in a co$ntry 3"ere t"ere is no environ%ental legislation. Ho3ever, t"e co%pany "as a 3idely p$blis"ed environ%ental policy in 3"ic" it $nderta<es to clean $p all conta%ination t"at it ca$ses. 1"e enterprise "as a record of "ono$ring t"is p$blis"ed policy. ,e4uired" Disc$ss 3"et"er t"e provision can be %ade by .D >tdA !olution"

,7)*

(b)

Second criterion probable outflow of economic resources embodying economic benefits An o$tflo3 of reso$rces is regarded as probable if t"e o$tflo3 is %ore li<ely t"an not to occ$r (i.e. "aving a probability greater than 567). Example 8 0 9arranties ( ) 0, >td gives 3arranties at t"e ti%e of sale to p$rc"asers of its prod$ct to repair or replace any defects 3it"in t"ree years fro% t"e date of sale. 9n past e!perience, it is probable (i.e. %ore li<ely t"an not) t"at t"ere 3ill be so%e clai%s $nder t"e 3arranties. Present obligation as a result of a past obligating event @ 1"e obligating event is t"e sale of t"e prod$ct 3it" a 3arranty, 3"ic" gives rise to a legal obligation. An outflow of resources embodying economic benefits in settlement @ /robable for t"e 3arranties as a 3"ole. +onclusion @ A provision is recognised for t"e best esti%ate of t"e costs of %a<ing good $nder t"e 3arranty prod$cts sold before t"e state%ent of financial position date.

2.1&

2.1*

(c) 2.15

Third criterion reliable estimate of the obligation amount HKAS 37 states t"at a s$fficiently reliable esti%ate of t"e a%o$nt of obligation can be %ade, a provision is to be recogni2ed. 9nly in e!tre%ely rare cases 3ill it be gen$inely i%possible to %a<e a reliable esti%ate and a provision e!ists t"at cannot be recogni2ed. 'n t"is case, t"at liability s"o$ld be disclosed as a contingent liability.

,7)5

(D) 2.17

:easurement 'ey Points (a) 1"e a%o$nt recogni2ed as a provision s"o$ld be t"e best estimate of t"e e!pendit$re re#$ired to settle t"e obligation t"at e!isted at t"e state%ent of financial position date. (b) 1"e a%o$nt recogni2ed as a provision s"o$ld be6 (i) a realistic estimate (ii) a prudent estimate of t"e e!pendit$re needed to settle t"e obligation e!isting at t"e reporting date (iii) discounted 3"enever t"e effect of this is material.

2.17 2.18

2.2+

1"e esti%ates 3ill be deter%ined by t"e ($dge%ent of t"e entity:s %anage%ent s$pple%ented by t"e e!perience of si%ilar transactions. Allo3ance is %ade for uncertainty. ?"ere t"e provision being %eas$red involves a large population of items, t"e obligation is estimated by weighting all possible outcomes by t"eir associated probabilities, i.e. expected value. ?"ere t"e provision involves a single item, s$c" as t"e o$tco%e of a legal case, provision is %ade in full for t"e most likely outcome. Example 5 0 Determine the amount of provisions for a large population 9/ >td sells goods 3it" a 3arranty $nder 3"ic" c$sto%ers are covered for t"e cost of repairs of any defects t"at beco%e apparent 3it"in t"e first si! %ont"s after p$rc"ase. =ased on past e!perience and f$t$re e!pectation, it is esti%ated t"at if %inor defects 3ere detected in all goods sold, repair cost of B1+ %illion 3o$ld res$lt, b$t if %a(or defects 3ere detected for all t"e goods sold, repair costs of B&+ %illion 3o$ld res$lt. 1"e co%pany e!pects t"at for t"e year 7*C of t"e goods sold to "ave no defect, 2+C 3it" %inor defects and *C 3it" %a(or defects. 1"e a%o$nt of provisions for 3arranties is t"e e!pected val$e of t"e costs of repairs, B&% (7*C ! Bnil D 2+C ! B1+% D *C ! B&+%).

2.21

,7)7

2.22

Example ; 0 Discounting of provision A co%pany <no3s t"at 3"en it ceases a certain operation in * years ti%e it 3ill "ave to pay environ%ental clean$p costs of B* %illion. 1"e provision to be %ade no3 3ill be t"e present val$e of B* %illion in * years ti%e. 1"e relevant disco$nt rate in t"is case is 1+C. 1"erefore a provision 3ill be %ade for6 B 3,1+&,5++

B*% ! +.52+82E (E 1"e disco$nt rate for * years at 1+C) 1"e follo3ing year t"e provision 3ill be6 B*% ! +.583+1

3,&1*,+*+ 31+,*&+

1"e increase in t"e second year of B31+,&*+ 3ill be c"arged to profit or loss. 't is referred to as t"e unwinding of the discount. 1"is is acco$nted for as a finance cost. (E) 2.23 !pecific applications in practice HKAS 37 f$rt"er e!plains "o3 t"e general recognition and %eas$re%ent principles for provisions s"o$ld be applied in t"ree specific cases in practice6 (i) f$t$re operating losses4 (ii) onero$s contracts ( 9:)4 and (iii) restr$ct$ring costs. Future operating losses 'n t"e past, provisions "ave so%eti%es been recogni2ed for f$t$re operating losses on t"e gro$nds of pr$dence. ,o3, no provisions should be recogni-ed for future operating losses. 1"ose costs co$ld be avoided by t"e enterprise:s f$t$re actions4 t"$s t"ey do not %eet t"e definition of a liability and t"e
,7)7

(a) 2.2&

general recognition criteria for a provision. (b) 2.2* Onerous contracts An onero$s contract is a contract entered into 3it" anot"er party $nder 3"ic" t"e $navoidable costs of f$lfilling t"e ter%s of t"e contract e!ceed any reven$es e!pected to be received fro% t"e goods or services s$pplied and 3"ere t"e entity 3o$ld "ave to co%pensate t"e ot"er party if it did not f$lfill t"e ter%s of t"e contract. 1"e present obligation $nder an onerous contract s"o$ld be recogni-ed and measured as a provision. Example ) 0 $nerous contract Droopers plc "as recently bo$g"t all of t"e trade, assets and liabilities of Dolittle, an $nincorporated b$siness. As part of t"e ta<e)over all of t"e co%bined b$siness:s activities "ave been relocated at Droopers %ain site. As a res$lt Dolittle:s pre%ises are no3 e%pty and s$rpl$s to re#$ire%ents. Ho3ever, ($st before t"e ac#$isition Dolittle "ad signed a t"ree year lease for t"eir pre%ises at B5,+++ per calendar %ont". At 31 Dece%ber 2++5 t"is lease "ad 32 %ont"s left to r$n and t"e landlord "ad ref$sed to ter%inate t"e lease. A s$b)tenant "ad ta<en over part of t"e pre%ises for t"e rest of t"e lease at a rent of B2,*++ per calendar %ont". ,e4uired" (a) (b) S"o$ld Droopers recogni2e a provision for an onero$s contract in respect of t"is leaseA S"o3 "o3 t"is infor%ation 3ill be presented in t"e financial state%ents for 2++5 and 2++7. 'gnore t"e ti%e val$e of %oney.

2.25

!olution" (a) Droopers plc "as a legal obligation to pay a f$rt"er B182,+++ (B5,+++ ! 32 %ont"s) to t"e landlord, as a res$lt of a lease signed before t"e year end. 1"erefore an onero$s contract e!ists and %$st be provided for. 1"ere is also an a%o$nt recoverable fro% t"e s$b)tenant of B7+,+++
,7)8

(B2,*++ ! 32 %ont"s). 1"is 3ill be s"o3n separately in t"e state%ent of financial position as an asset. 1"e B182,+++ payable and t"e B7+,+++ recoverable can be netted off in t"e inco%e state%ent. (b) 2ncome statement /rovision for onero$s contract (net) ,et rental payable on lease (72 @ 3+) -elease of provision 2++5 B 112,+++ Dr ) 112,+++ Dr !tatement of financial position -eceivables A%o$nt recoverable fro% s$b) tenants >iabilities A%o$nts contracts payable on onero$s 7+,+++ Dr *+,+++ Dr 2++7 B ) &2,+++ Dr &2,+++ .r )

182,+++ .r

12+,+++ .r

(c) 2.27

Restructuring costs (;<=>) -estr$ct$ring incl$des ter%inating a line of b$siness, clos$re of b$siness locations, c"anges in %anage%ent str$ct$re, and refoc$sing a b$siness:s operations. 'n t"e past, provisions "ave fre#$ently been %ade for reorgani2ations and restr$ct$ring. -eorgani2ations %ay incl$de ter%inating a line of b$siness, t"e clos$re of locations 3"ere b$siness is carried on, c"anges in %anage%ent str$ct$re and cost red$ction progra%%es. A restr$ct$ring is a progra%%e t"at is planned and controlled by %anage%ent and "as a %aterial effect on6 (i) t"e scope of a b$siness $nderta<en by t"e reporting entity in ter%s of t"e prod$cts or services it provides, or (ii) t"e %anner in 3"ic" a b$siness $nderta<en by t"e reporting entity is cond$cted. 't re#$ires t"at provisions for reorgani2ationFrestr$ct$ring s"o$ld be
,7)1+

2.27

2.28

2.3+

recogni2ed only 3"en an entity is de%onstrably co%%itted to t"e reorgani2ation, i.e., specific actions %$st "ave been ta<en so t"at ot"ers can be e!pected to act on t"e basis t"at t"e reorgani2ation 3ill proceed and in so doing, leave t"e entity 3it"o$t realistic possibility of 3it"dra3al.

2.31

'ey Points (a) Evidence of the commitment %ig"t be6 (i) t"e public announcement of t"e detailed plan4 (ii) t"e commencement of i%ple%entation (e.g., dis%antling plant, selling assets, notifying e!ternal parties and co%%$nication to e%ployees)4 (iii) ot"er circ$%stances constructively obliging t"e entity to co%plete t"e reorgani2ation. 1"e detailed plan s"o$ld identify (as a minimum)6 (i) t"e business or part of a business concerned4 (ii) t"e principal locations affected4 (iii) t"e location* function and approximate number of employees 3"ose services are to be ter%inated or d$ties c"anged4 (iv) t"e expenditures t"at 3ill be $nderta<en4 and (v) t"e time at 3"ic" t"e plan 3ill be i%ple%ented. '%ple%entation s"o$ld begin as soon as possible and t"e period of ti%e to co%plete i%ple%entation s"o$ld be s$c" t"at significant c"anges to t"e plan are li<ely. A board decision on its own is not a demonstrable commitment , $nless t"e %e%bers"ip of t"e =oard contains representatives of interests ot"er t"an %anage%ent, as is t"e case in so%e co$ntries. Announcement of plans to the public or to employees might constitute commitment , depending on t"e level of detail co%%$nication.

(b)

(c)

2.32

/rovisions for reorgani2ations s"o$ld incl$de only t"ose e!pendit$res t"at are bot"6 (a) necessarily entailed by a reorgani2ation to 3"ic" t"e entity is de%onstrably co%%itted4 and (b) not associated with ongoing or new activities of the entity .
,7)11

!a%ples of costs t"at are not allo3ed incl$de6 retraining or relocating contin$ing staff4 invest%ent in ne3 syste%s and distrib$tion net3or<s, etc., beca$se t"ese e!pendit$res relate to t"e f$t$re operation of t"e enterprise and are not liabilities for restr$ct$ring at t"e state%ent of financial position date. 2.33 Example < 9n 1* ;an$ary 2++7 t"e =oard of Directors of S"ane >td voted to proceed 3it" t3o re)organisation sc"e%es. S"ane >td:s financial year end is 31 0arc", and t"e financial state%ents 3ill be finali2ed and p$blis"ed on 3+ ;$ne. !cheme 1"e clos$re costs 3ill a%o$nt to B12*,+++. 1"e factory is rented on a s"ort) ter% lease, and t"ere 3ill be no gains or losses arising on t"is property. 1"e clos$re 3ill be anno$nced in ;$ne, and 3ill co%%ence in A$g$st. !cheme / 1"e costs 3ill a%o$nt to B&*,+++ (after crediting B1+*,+++ profit on disposal of certain %ac"ines). 1"e clos$re 3ill ta<e place in ;$ly, b$t red$ndancy negotiations began 3it" t"e staff in 0arc". !plain and calc$late t"e year)end restr$ct$ring provision. !olution" !cheme @ 1"e obligation arises in ;$ne, after t"e year end, and so t"ere 3ill be no provision. Ho3ever, t"e anno$nce%ent in ;$ne s"o$ld be disclosed as an event after t"e state%ent of financial position. !cheme / @ Alt"o$g" t"e clos$re 3ill not begin $ntil ;$ly, t"e e%ployees 3ill "ave "ad a valid e!pectation t"at it 3o$ld "appen 3"en t"e red$ndancy negotiations began in 0arc". 1"erefore a provision s"o$ld be recognised. 1"e provision 3ill be for B1*+,+++ beca$se t"e e!pected profit on disposal cannot be netted off against t"e e!pected costs. 2.3& Exercise ( 0 :easuring restructuring provisions 9n 1 9ctober 2++7 t"e =oard of 0, >td resolved to close t"e loss)%a<ing
,7)12

engineering division. A binding agree%ent to dispose of t"e assets 3as signed on 7 9ctober 2++7. 1"e sale 3ill be co%pleted on 1& 0arc" 2++7 at an agreed val$e of B3+ %illion. 1"e esti%ated costs of t"e clos$re are6 red$ndancy, B2 %illion4 penalty costs for non)co%pletion of contracted orders, B3 %illion4 related professional costs, B1.* %illion4 losses on t"e sale of t"e net assets and liabilities, 3"ose carrying a%o$nt at t"e state%ent of financial position date of 31 Dece%ber 2++7 3as B55 %illion and B2+ %illion respectively4 and esti%ated operating losses for t"e period fro% 1 ;an$ary 2++7 to t"e date of sale, B&.* %illion. ,e4uired" +alculate the provisions :1 =td should be made> !olution"

,7)13

3.
(A) 3.1

Contingent iabi!ities and Contingent Assets

+ontingent liabilities Definition A contingent liabilities is defined in HKAS 37 as6 (i) a possible obligation t"at arise fro% past events and 3"ose existence 3ill be confirmed only by the occurrence or non?occurrence of one or %ore $ncertain future events not wholly within the control of t"e enterprise4 or (ii) a present obligation t"at arises fro% past events b$t is not recogni2ed beca$se it is not probable t"at an outflow of resources e%bodying econo%ic benefits 3ill be re#$ired to settle t"e obligation4 or t"e amount of t"e obligation cannot be measured 3it" s$fficient reliability.

3.2

A provision and contingent liability is disting$is"ed on t"e basis t"at an enterprise s"o$ld never recogni-e a contingent liability. Ho3ever, a contingent liability s"o$ld be disclosed in the notes to accounts, $nless t"e possibility of an o$tflo3 of reso$rces e%bodying econo%ic benefits is re%ote. Example @ 0 +ontingent liabilities (i) =itigation @ /ending or t"reatened litigation needs to be disclosed. 1"e nat$re of t"e litigation %ay ta<e %any for%s, s$c" as da%age to t"e environ%ent (e.g. poll$ting air, rivers, etc.) Auarantees @ .o%panies often g$arantee t"e liabilities of ot"ers. Gor e!a%ple, co%panies ($s$ally 3it"in a gro$p) often g$arantee eac" ot"er:s ban< borro3ings or overdrafts.

3.3

(ii)

(#) 3.&

+ontingent assets Definition A contingent asset is defined as a possible asset t"at arises from past events and 3"ose existence will be confirmed only by the occurrence or non? occurrence of one or more uncertain future events not wholly within the control of t"e enterprise.
,7)1&

3.*

3.5

.ontingent assets are not recogni-ed in financial statements beca$se to do so co$ld res$lt in t"e recognition of inco%e t"at %ay never be reali2ed. A contingent asset is to be disclosed 3"ere an inflo3 of econo%ic benefits is probable. 1"e acco$ntingFdisclos$re re#$ire%ents are s$%%ari2ed in t"e follo3ing table6 Degree of probability of an outflowBinflow of resources Hirt$ally /robable /ossible -e%ote $utflow >iability >iability Disclose by note ,o disclos$re 2nflow Asset Disclose by note ,o disclos$re ,o disclos$re

".
(A) &.1

#isc!osure Re$uire%ents
Provision Gor eac" class of provision, t"e follo3ing disclos$res are re#$ired6 (i) a %ove%ent sc"ed$le reconciling t"e carrying a%o$nt of beginning balance to t"e carrying a%o$nt ending balance for t"e period, disclosing6 additional provisions, incl$ding increases to e!isting provisions4 a%o$nts $sed (i.e., inc$rred and c"arged against t"e provision)4 $n$sed a%o$nts reversed4 and t"e increase in t"e disco$nted a%o$nt arising fro% t"e passage of ti%e and t"e effect of any c"ange in t"e disco$nt rate4 a brief description of t"e nat$re of t"e obligation and t"e e!pected ti%ing of any res$lting o$tflo3 of econo%ic reso$rces4 an indication of t"e $ncertainties abo$t t"e a%o$nt or ti%ing of t"ose o$tflo34 and t"e a%o$nt of any e!pected rei%b$rse%ent, starting t"e a%o$nt of any asset t"at "as been recogni2ed for t"at e!pected rei%b$rse%ent.

(ii) (iii) (iv)

(#)

+ontingent liability

,7)1*

&.2

?"ere a contingent liability is disclosed, t"e enterprise is to provide a brief description of t"e nat$re of t"e contingent liability. 'n addition, t"e follo3ing infor%ation is re#$ired6 (i) an esti%ate of its financial effect4 (ii) an indication of t"e $ncertainties relating to t"e a%o$nt or ti%ing of any o$tflo34 and (iii) t"e possibility of any rei%b$rse%ent. +ontingent asset ?"ere a contingent asset is disclosed, t"e follo3ing infor%ation is re#$ired6 (i) a brief description of t"e nat$re of t"e contingent asset4 and (ii) an esti%ate of its financial effect @ 3"ere t"is is not disclosed beca$se it is not practicable to do so, t"at fact s"o$ld be stated. 1"e 1ent" Sc"ed$le to t"e .o%panies 9rdinance also re#$ires t"at 3"ere contingencies "ave not been provided for in t"e financial state%ents, t"e follo3ing infor%ation s"o$ld be disclosed6 (i) (ii) t"e general nat$re of any ot"er contingent liabilities not provided for4 and 3"ere practicable, t"e aggregate a%o$nt or esti%ated a%o$nt of t"ose liabilities, if it is %aterial.

(+) &.3

&.&

(D) &.*

Clow chart 1"e follo3ing decision tree is to s$%%arise t"e %ain recognition re#$ire%ents of t"e Standard for provisions and contingent liabilities.

,7)15

,7)17

&.
*.1

Events after the Reporting Period

Definition (a) vents after t"e reporting period are t"ose events, both favourable and unfavourable, t"at occur between the end of reporting period and the date on 3"ic" t"e financial statements are authori-ed for issue ( 7?0@ABCDEFG7?HIJ K ?LMNOHPAB+I+). 1"ere are t3o types of s$c" events6 (i) ad%usting events ( ) @ t"ose providing further evidence of conditions t"at existed at the end of reporting period. 1"ese events %$st be ad($sted for in t"e financial state%ents. (ii) non?ad%usting events ( ) @ t"ose t"at are indicative of conditions t"at arose after the reporting period. 1"ese do not re4uire ad%ustment, but must be disclosed by note or ot"er3ise if material.

(b)

*.2

'n so%e cases, an entity is re#$ired to s$b%it its financial state%ents to its s"are"olders for approval after t"e financial state%ents "ave been iss$ed. 'n s$c" cases, t"e financial state%ents are a$t"orised for iss$e on t"e date of iss$e, not t"e date 3"en s"are"olders approve t"e financial state%ents. Example 6 1"e %anage%ent of an entity co%pletes draft financial state%ents for t"e year to 31 Dece%ber 2++7 on 27 Gebr$ary 2++7. 9n 17 0arc" 2++7, t"e board of directors revie3s t"e financial state%ents and a$t"orises t"e% for iss$e. 1"e entity anno$nces its profit and selected ot"er financial infor%ation on 18 0arc" 2++7. 1"e financial state%ents are %ade available to s"are"olders and ot"ers on 1 April 2++7. 1"e s"are"olders approve t"e financial state%ents at t"eir ann$al %eeting on 1* 0ay 2++7 and t"e approved financial state%ents are t"en filed 3it" a reg$latory body on 17 0ay 2++7. 1"e financial state%ents are a$t"orised for iss$e on 17 0arc" 2++7 (date of board a$t"orisation for iss$e).

*.3

,7)17

*.&

Exercise 8 9n 17 0arc" 2++7, t"e %anage%ent of an entity a$t"orises financial state%ents for iss$e to its s$pervisory board. 1"e s$pervisory board is %ade $p solely of non)e!ec$tives and %ay incl$de representatives of e%ployees and ot"er o$tside interests. 1"e s$pervisory board approves t"e financial state%ents on 25 0arc" 2++7. 1"e financial state%ents are %ade available to s"are"olders and ot"ers on 1 April 2++7. 1"e s"are"olders approve t"e financial state%ents at t"eir ann$al %eeting on 1* 0ay 2++7 and t"e financial state%ents are t"en filed 3it" a reg$latory body on 17 0ay 2++7. ?"en is t"e date of a$t"ori2ation for t"e iss$ance of financial state%entsA

(A) *.*

Examples of ad%usting events 1"e follo3ing e!a%ples are nor%ally classified as ad($sting events6 (i) Cixed assets @ t"e s$bse#$ent deter%ination after t"e state%ent of financial position date of t"e p$rc"ase price or sales proceeds of assets p$rc"ased or sold before state%ent of financial position date. (ii) 2mpairment @ t"e receipt of infor%ation after t"e state%ent of financial position date indicating t"at an asset 3as i%paired at t"e state%ent of financial position date. (iii) Provision @ t"e resol$tion after t"e state%ent of financial position date of a co$rt case 3"ic", beca$se it confir%s t"at an enterprise already "ad a present obligation at t"e state%ent of financial position date, re#$ires an enterprise to recogni2e a provision. (iv) Profit sharing or bonus payments @ t"e deter%ination after t"e state%ent of financial position date of t"e a%o$nt of profit s"aring or bon$s pay%ents, if an enterprise already "ad a present obligation at t"e state%ent of financial position date to %a<e s$c" pay%ents as a res$lt of event before t"at date. (v) Discoveries @ t"e discovery of significant errors or fra$ds t"at render t"e financial state%ents incorrect or %isleading.

,7)18

*.5

Example A %a(or c$sto%er 3ent into li#$idation on 25 April 2+11. 1"e c$sto%er:s balance at 31 0arc" 2+11 re%ains $npaid. 1"e receiver "as inti%ated t"at $nsec$red payables 3ill receive very little co%pensation, if any. ,e4uired" !plain "o3 t"e above %atter s"o$ld be dealt 3it" in t"e financial state%ents for t"e year ended 31 0arc" 2+11. !olution" 1"e %a(or c$sto%er 3ent into li#$idation 25 April 2+11 and it is no3 clear t"at t"is balance is not recoverable. 1"e li#$idation is t"erefore an ad($sting event, and t"e a%o$nt of bad debt s"o$ld be 3ritten off in t"e co%pany:s financial state%ent for t"e year ended 31 0arc" 2+11.

(#) *.7

Examples of non?ad%usting events 1"e follo3ing e!a%ples are classified as non)ad($sting events6 (i) =$siness co%binations (ii) -estr$ct$ring (iii) Discontin$ing operations (iv) /$rc"ases or disposal of assets (v) Gire (vi) S"are transactions (vii) Goreign e!c"ange @ abnor%al large c"anges in asset prices or foreign e!c"ange rates (viii) 1a! @ c"anges in ta! ratesFla3s (i!) .o%%it%ents or contingent liabilities (!) >itigation Example / A fire bro<e o$t at t"e co%pany:s factory on & April 2+11. 1"is "as destroyed t"e factory:s ad%inistration bloc<. 0any of t"e costs inc$rred as a res$lt of
,7)2+

*.7

t"is fire are $nins$red. ,e4uired" !plain "o3 t"e above %atter s"o$ld be dealt 3it" in t"e financial state%ents for t"e year ended 31 0arc" 2+11. !olution" 1"e fire bro<e o$t on & April 2+11, after end of t"e reporting period of 31 0arc" 2+11, so t"is is an event after t"e reporting period $nder HKAS 1+. 0oreover, t"ere is no evidence of a fire secretly si%%ering ( QRA) at end of t"e reporting period and e!ploding into life on & April 2+114 t"e evidence is t"at t"ere 3as no fire at 31 0arc". 1"erefore, details of t"e fire s"o$ld be disclosed in a note to t"e acco$nts, so t"at reader can "ave a proper $nderstanding of t"e co%pany:s affairs. *.8 Exercise 5 HKAS 1+ reg$lates t"e e!tent to 3"ic" events after t"e reporting period s"o$ld be reflected in financial state%ents. ?"ic" of t"e follo3ing lists of s$c" events, 3"ic" offers after t"e end of t"e reporting period b$t before t"e approval of financial state%ents, consists only of ite%s t"at, according to HKAS 1+ s"o$ld nor%ally be classified as non) ad($stingA 1. 2. 3. &. *. 'nsolvency of a debtor 3"ose acco$nt receivable 3as o$tstanding at end of t"e reporting period. 'ss$e of s"ares or loan notes. ."anges in foreign e!c"ange rates 3"ic" relates to sales before end of t"e reporting period. A %a(or %erger 3it" anot"er co%pany. Destr$ction of a %a(or non)c$rrent asset by fire.

!olution"

,7)21

(+) (a) *.1+

$ther related issues Date of authori ation for issue An enterprise is re#$ired to disclose6 (i) t"e date 3"en t"e financial state%ents 3ere a$t"ori2ed for iss$e, and (ii) 3"o gave t"at a$t"ori2ation. !roposed dividends 9rdinary s"are dividends t"at are proposed or declared after the statement of financial position date s"o$ld not be recogni-ed as a liability in t"e state%ent of financial position. 1"e reason is t"at s$c" proposed dividends do not %eet t"e recognition criteria of a liability. 1"e enterprise does not have a present obligation at the statement of financial position date in respect of dividends proposed or declared after t"e state%ent of financial position date. 1"ese dividends should be disclosed in a note to t"e financial state%ents. "oing concern HKAS 1+ provides t"at an enterprise s"o$ld not prepare its financial state%ents on a going concern basis if %anage%ent deter%ines after t"e state%ent of financial position date eit"er t"at it intends to li#$idate t"e enterprise or to cease trading, or t"at is "as no realistic alternative b$t to do so. Ho3ever, it is i%portant to note t"at financial state%ents s"o$ld not be ad($sted 3"ere an event after t"e reporting period indicates t"at t"e going concern ass$%ption is not appropriate only for part of t"e enterprise. Disclosure re4uirements #d$usting events Separate disclos$re of ad($sting events is not re#$ired as t"ey do not %ore
,7)22

(b) *.11

*.12 (c) *.13

*.1&

(D) (a) *.1*

t"an provide additional evidence in s$pport of ite%s already recogni2ed in t"e financial state%ents. (b) *.15 %on&ad$usting events 'n respect of eac" non)ad($sting events after t"e reporting period 3"ic" is re#$ired to be disclosed (i.e. %aterial), t"e follo3ing infor%ation s"o$ld be stated by 3ay of notes to t"e financial state%ents6 (i) t"e nat$re of t"e event, and (ii) t"e esti%ate of t"e financial effect, or a state%ent t"at it is not practicable to %a<e s$c" an esti%ate.

,7)23

Examination !tyle Duestions Duestion (a) 1"e definition of a liability for%s an i%portant ele%ent of t"e Hong Kong 'nstit$te of .ertified /$blic Acco$ntants: Gra%e3or< for t"e /reparation and /resentation of Ginancial State%ents 3"ic", in t$rn, for%s t"e basis for HKAS 37 /rovisions, .ontingent >iabilities and .ontingent Assets.

,e4uired" Define a liability and describe t"e circ$%stances $nder 3"ic" provisions s"o$ld be recognised. Iive t3o e!a%ples of "o3 t"e definition of liabilities en"ances t"e reliability of financial state%ents. (* %ar<s) (b) 9n 1 9ctober 2++7, /ro%oil ac#$ired a ne3ly constr$cted oil platfor% at a cost of B3+ %illion toget"er 3it" t"e rig"t to e!tract oil fro% an offs"ore oilfield $nder a govern%ent licence. 1"e ter%s of t"e licence are t"at /ro%oil 3ill "ave to re%ove t"e platfor% (3"ic" 3ill t"en "ave no val$e) and restore t"e sea bed to an environ%entally satisfactory condition in 1+ years: ti%e 3"en t"e oil reserves "ave been e!"a$sted. 1"e esti%ated cost of t"is on 3+ Septe%ber 2+17 3ill be B1* %illion. 1"e present val$e of B1 receivable in 1+ years at t"e appropriate disco$nt rate for /ro%oil of 7C is B+J&5. ,e4uired" (i) !plain and #$antify "o3 t"e oil platfor% s"o$ld be treated in t"e financial state%ents of /ro%oil for t"e year ended 3+ Septe%ber 2++74 (7 %ar<s) Describe "o3 yo$r ans3er to (b)(i) 3o$ld c"ange if t"e govern%ent licence did not re#$ire an environ%ental clean $p. (3 %ar<s) (1* %ar<s) (A..A G7 (HKI) Ginancial -eporting Dece%ber 2++7 K&)

(ii)

,7)2&

Duestion / After t"e end of t"e reporting period, prior to a$t"orising for iss$e t"e financial state%ents of 1entacle for t"e year ended 31 0arc" 2++7, t"e follo3ing %aterial infor%ation "as arisen. (i) 1"e notification of t"e ban<r$ptcy of a c$sto%er. 1"e balance of t"e trade receivable d$e fro% t"e c$sto%er at 31 0arc" 2++7 3as B23,+++ and at t"e date of t"e notification it 3as B2*,+++. ,o pay%ent is e!pected fro% t"e ban<r$ptcy proceedings. (3 %ar<s) (ii) Sales of so%e ite%s of prod$ct ?32 3ere %ade at a price of B*J&+ eac" in April and 0ay 2++7. Sales staff receive a co%%ission of 1*C of t"e sales price on t"is prod$ct. At 31 0arc" 2++7 1entacle "ad 12,+++ $nits of prod$ct ?32 in inventory incl$ded at cost of B5 eac". (& %ar<s) (iii) 1entacle is being s$ed by an e%ployee 3"o lost a li%b in an accident 3"ile at 3or< on 1* 0arc" 2++7. 1"e co%pany is contesting t"e clai% as t"e e%ployee 3as not follo3ing t"e safety proced$res t"at "e "ad been instr$cted to $se. Accordingly t"e financial state%ents incl$de a note of a contingent liability of B*++,+++ for personal in($ry da%ages. 'n a recently decided case 3"ere a si%ilar in($ry 3as s$stained, a settle%ent fig$re of B7*+,+++ 3as a3arded by t"e co$rt. Alt"o$g" t"e in($ry 3as si%ilar, t"e circ$%stances of t"e accident in t"e decided case are different fro% t"ose of 1entacle:s case. (& %ar<s) ,e4uired" State and #$antify "o3 ite%s (i) to (iii) above s"o$ld be treated 3"en finalising t"e financial state%ents of 1entacle for t"e year ended 31 0arc" 2++7. (A..A 2.* (HKI) Ginancial -eporting ;$ne 2++7 K*(b))

,7)2*

Duestion ( HKAS 37 L/rovisions, .ontingent >iabilities and .ontingent Assets: 3as iss$ed in 1887. 1"e Standard sets o$t t"e principles of acco$nting for t"ese ite%s and clarifies 3"en provisions s"o$ld and s"o$ld not be %ade. /rior to its iss$e, t"e inappropriate $se of provisions "ad been an area 3"ere co%panies "ad been acc$sed of %anip$lating t"e financial state%ents and of creative acco$nting. ,e4uired" (a) (b) Describe t"e nat$re of provisions and t"e acco$nting re#$ire%ents for t"e% contained in HKAS 37. (5 %ar<s) !plain 3"y t"ere is a need for an acco$nting standard in t"is area. 'll$strate yo$r ans3er 3it" t"ree practical e!a%ples of "o3 t"e standard addresses controversial iss$es. (5 %ar<s) =odyline sells sports goods and clot"ing t"ro$g" a c"ain of retail o$tlets. 't offers c$sto%ers a f$ll ref$nd facility for any goods ret$rned 3it"in 27 days of t"eir p$rc"ase provided t"ey are $n$sed and in t"eir original pac<aging. 'n addition, all goods carry a 3arranty against %an$fact$ring defects for 12 %ont"s fro% t"eir date of p$rc"ase. Gor %ost goods t"e %an$fact$rer $nder3rites t"is 3arranty s$c" t"at =odyline is credited 3it" t"e cost of t"e goods t"at are ret$rned as fa$lty. Ioods p$rc"ased fro% one %an$fact$rer, Header, are sold to =odyline at a negotiated disco$nt 3"ic" is designed to co%pensate =odyline for %an$fact$ring defects. ,o ref$nds are given by Header, t"$s =odyline "as to bear t"e cost of any %an$fact$ring fa$lts of t"ese goods. =odyline %a<es a $nifor% %ar< $p on cost of 2*C on all goods it sells, e!cept for t"ose s$pplied fro% Header on 3"ic" it %a<es a %ar< $p on cost of &+C. Sales of goods %an$fact$red by Header consistently acco$nt for 2+C of all =odyline:s sales. Sales in t"e last 27 days of t"e trading year to 3+ Septe%ber 2++3 3ere B1,7*+,+++. /ast trends reliably indicate t"at 1+C of all goods are ret$rned $nder t"e 27)day ret$rn facility. 1"ese are not fa$lty goods. 9f t"ese 7+C are later resold at t"e nor%al selling price and t"e re%aining 3+C are sold as Lsale: ite%s at "alf t"e nor%al retail price. 'n addition to t"e above e!pected ret$rns, an esti%ated B15+,+++ (at selling
,7)25

(c)

price) of t"e goods sold d$ring t"e year 3ill "ave %an$fact$ring defects and "ave yet to be ret$rned by c$sto%ers. Ioods ret$rned as fa$lty "ave no resale val$e. ,e4uired" Describe t"e nat$re of t"e above 3arrantyFret$rn facilities and calc$late t"e provision =odyline is re#$ired to %a<e at 3+ Septe%ber 2++36 (i) for goods s$b(ect to t"e 27 day ret$rns policy4 and (ii) for goods t"at are li<ely to be fa$lty. (7 %ar<s) -oc<b$ster "as recently p$rc"ased an ite% of eart" %oving plant at a total cost of B2& %illion. 1"e plant "as an esti%ated life of 1+ years 3it" no resid$al val$e, "o3ever its engine 3ill need replacing after every *,+++ "o$rs of $se at an esti%ated cost of B7J* %illion. 1"e directors of -oc<b$ster intend to depreciate t"e plant atB2J& %illion (B2& %illionF1+ years) per ann$% and %a<e a provision of B1,*++ (B7J* %illionF*,+++ "o$rs) per "o$r of $se for t"e replace%ent of t"e engine. ,e4uired" !plain "o3 t"e plant s"o$ld be treated in accordance 3it" 'nternational Acco$nting Standards and co%%ent on t"e Directors: proposed treat%ent. (* %ar<s) (2* %ar<s) (A..A 2.*(HKI) Ginancial -eporting Dece%ber 2++3 K3)

(d)

,7)27

Duestion 8 Sea >i%ited, a p$blic co%pany, p$rc"ased a coal %ine and its related plant on 1 ;an$ary 2++7. D$ring t"e year to 31 Dece%ber 2++7, a ne3 nviron%ental >egislation "ad been passed and enforced 3it" i%%ediate effect. 1"is >egislation re#$ires Sea >i%ited to landscape t"e area affected by t"e %ining activities d$ring t"e esti%ated life of t"e coal %ine. At 31 Dece%ber 2++7, t"e esti%ated econo%ic life of t"e coal %ine is ten years. At t"e sa%e ti%e, t"e f$t$re costs of t"e landscape, 3"ic" "ave been esti%ated by a professional s$rveyor 3it" s$fficient e!perience to be B152,+++, "ave to be disco$nted at 7C to t"e present val$e as of 1 ;an$ary 2++7. ,e4uired" (a) (b) State t"e definitions of M.ontingent >iabilitiesN and M.ontingent AssetsN. (* %ar<s) Disc$ss and e!plain t"e appropriate acco$nting treat%ents for t"e year ended 31 Dece%ber 2++7 of t"e event given in t"e #$estion.
1"e %ar<s allocation for part (b)6 (i) (ii) (iii) (iv) ?"et"er provision s"o$ld be %ade for landscaping =est esti%ate for t"e a%o$nt of provision for landscaping .osts of property, plant and e#$ip%ent Acco$nting entries to record t"is transaction 1otal %ar<s * 7 & & 2+

(Oo$r ans3er s"o$ld be in line 3it" t"e re#$ire%ents of HKAS 15 M/roperty, /lant and #$ip%entN and HKAS 37 M/rovisions, .ontingent >iabilities and .ontingent AssetsN) (1otal 2* %ar<s) (HK'AA1 /aper 7 Advanced Acco$nting ;$ne 2++7 .&)

,7)27

Duestion 5 %erald >in< >td engages in t"e prod$ction and distrib$tion of $p)%ar<et (e3ellery prod$cts. 1"e co%pany:s (e3ellery is 3ell <no3n for its design as 3ell as its policy of red$cing poll$tion to a %ini%$% in t"eir prod$ction. 'n preparing t"e final acco$nts of t"e co%pany for t"e financial year ended 31 Dece%ber 2++7, t"e financial controller "as noted t"e follo3ing material events6 (1) D$ring Dece%ber 2++7, t"e co%pany:s prod$ction plant in Hietna% accidentally ca$sed c"e%ical poll$tion to a local river. 1"ere is no environ%ental la3 prevailing in t"e co$ntry re#$iring t"e clean $p of poll$tion by t"e poll$ter. 1"e cons$ltant "as esti%ated t"at an a%o$nt of B2+% is re#$ired for a proper clean $p of t"e conta%ination. 1"e board of directors "as resolved to close do3n part of t"e prod$ction facilities in Hong Kong and %ove it to t"e %ainland ."ina in a board %eeting "eld on 28 Dece%ber 2++7. 1"e relocation plan toget"er 3it" details of a red$ndancy pac<age 3as anno$nced to t"e staff concerned t"e ne!t day. 1"e total a%o$nt of co%pensation pay o$t 3as esti%ated to be aro$nd B*.*%. 9n * ;an$ary 2++8, t"e staff in t"e prod$ction depart%ent discovered t"at a b$rglary "ad ta<en place d$ring 3ee<end. 1"e co%pany "ad reported t"e incidence to t"e police. A stoc<ta<e 3as carried o$t and it 3as noted t"at appro!i%ately stoc< val$ed at B2*.5% 3as stolen. 1"e ins$rance co%pany "as confir%ed t"e co%pany can receive co%pensation $p to *+C of t"e loss. 9n 2 Gebr$ary 2++8, t"e co%pany 3as s$ed by -oyal =l$e >td., a PK (e3ellery design co%pany, for infringe%ent of copyrig"t. 1"e clai% a%o$nt 3as B&+%. According to legal opinion, t"e co%pany %ay not "ave a good c"ance to defend t"e case s$ccessf$lly. 9n 1+ Gebr$ary 2++8 t"e co%pany 3as infor%ed by its la3yer t"at one of its %a(or c$sto%ers in t"e PSA, Iiant >td, "as filed for ban<r$ptcy and li#$idation proced$re "as co%%enced. 1otal debt o3ed by Iiant >td a%o$nted to B17.*%, o$t of 3"ic" B7.*% 3as represented by a s"ip%ent on 7 ;an$ary 2++8.

(2)

(3)

(&)

(*)

,e4uired" 1"e final acco$nts of %erald >in< >td is a$t"ori2ed for iss$e on 15 0arc" 2++8.

,7)28

'n accordance 3it" HKAS 37 M/rovisions, .ontingent >iabilities and .ontingent AssetsN, and HKAS 1+ M vents after t"e -eporting /eriodN, for eac" of t"e ite%s above @

(a) (b) (c)

'dentify t"e acco$nting iss$es and e!plain t"e appropriate acco$nting treat%ent. S"o3 (o$rnal entries for acco$nting ad($st%ents, if re#$ired. /repare notes to t"e acco$nts for disclos$re, if re#$ired.

0ar< Allocation 0aterial vents 0ar<s (1) * (2) * (3) & (&) * (*) 5 (1otal 2* %ar<s) (HK'AA1 /aper 7 Ginancial Acco$nting ;$ne 2++8 .2)

,7)3+