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FFQA 26
IAS 37
PROVISIONS AND CONTINGENCIES
FFQA 27
FFQA SUMMARY CHANCES OF OUTFLOW 90% TO 100% > 50% < 50% 1% TO 5%
TREATMENT RECOGNIZED IT AS AN LIABILITY IN SFP (CERTAIN) RECOGNIZED IT AS A PROVISION IN SFP (PROBABLE) DISCLOSE IT AS A CONTINGENT LIABILITY (POSSIBLE / NOT PROBABLE) DO NOTHING (REMOTE)
TREATMENT RECOGNIZED IT AS A ASSET IN SFP (CERTAIN) > 50% DISCLOSE IT AS A CONTINGENT ASSET (PROBABLE) IN THE CASE OF INFLOW ALL OTHER CATEGORIES ARE IRRELEVANT.
FFQA 28
Provisions
The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition
Definition of PROVISION
Liability: present obligation as a result of past events settlement is expected to result in an outflow of resources (payment) A provision is a liability of uncertain timing or amount.
Recognition
The recognition criteria are the same as those in the Framework for all liabilities: (i) When an entity has a present obligation (legal or constructive) as a result of a past event; (ii) It is probable that an outflow of economic resources will be required to settle the obligation, and (iii) A reliable estimate can be made of the amount of the obligation. Unless these conditions are met, no provision can be recognised. Provisions should be reviewed each year and adjusted to reflect current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required, the provision should be reversed. A past event which leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the entity has no realistic alternative to settling that obligation created by the event. A legal obligation is one that derives from a contract, legislation or any other operation of law.
COPYRIGHT 2010 BY Mohammad Faizan Farooq A constructive obligation is an obligation that derives from the actions of an entity where: (i) From an established pattern of past practice, published policies or a specific statement the entity has indicated to other parties that it will accept certain responsibilities; and (ii) As a result the entity has created a valid expectation in other parties that it will discharge those responsibilities
FFQA 29
Examples of Provisions
CIRCUMSTANCE Accrue a Provision? RESTRUCTURING BY SALE OF AN Accrue a provision only after a binding sale OPERATION agreement RESTRUCTURING BY CLOSURE OR Accrue a provision only after a detailed formal REORGANIZATION plan is adopted and announced publicly. A Board decision is not enough WARRANTYAccrue a provision LAND CONTAMINATIONAccrue a provision if the company's policy is to clean up even if there is no legal requirement to do so (past event is the obligation and public expectation created by the company's policy) CUSTOMER REFUNDSAccrue if the established policy is to give refunds (past event is the customer's expectation, at time of purchase, that a refund would be available) OFFSHORE OIL RIG MUST BE Accrue a provision when installed, and add to the REMOVED AND SEA BED RESTORED cost of the asset ABANDONED LEASEHOLD, FOUR Accrue a provision YEARS TO RUN CPA FIRM MUST STAFF TRAINING FOR No provision (there is no obligation to provide RECENT CHANGES IN TAX LAW the training) MAJOR OVERHAUL OR REPAIRSNo provision (no obligation) ONEROUS (LOSS-MAKING) CONTRACTAccrue a provision
FFQA 30
Measurement
The amount recognised as a provision is the best estimate of the expenditure required to settle the obligation at the balance sheet date. Provisions should be discounted where the effect of the time value of money is Material.
Recognition
An entity should not recognise a contingent liability. A contingent liability is disclosed unless the possibility of an outflow of economic benefits is remote.
Recognition
An entity should not recognise a contingent asset because it could result in the recognition of profits that may never be realised. However, where the realisation of profit is virtually certain, then the related asset is not a contingent asset and recognition is appropriate. A contingent asset is disclosed where an inflow of economic benefits is probable. Provisions should not be recognised for future operating losses. Future operating losses do not meet the definition of a liability or the Framework recognition criteria.
FFQA 31
Onerous contracts
If an entity has a contract that is onerous a provision should be made for the net loss. IAS 37 defines an onerous contract as one in which unavoidable costs of completing the contract exceed the benefits expected to be received under it
Restructuring
A provision for restructuring costs is recognised only when the entity has a constructive obligation to restructure. Such an obligation only arises where an entity: (i) Has a detailed formal plan for the restructuring, and (ii) Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement the plan or announcing its main features to those affected by it. A restructuring provision should include only direct expenditures arising from the restructuring and which are: (a) Necessarily entailed by the restructuring; and (b) Not associated with the ongoing activities of the entity. A restructuring provision does not include such costs as: Retraining or relocating continuing staff; Marketing; or Investment in new systems and distribution networks.
COPYRIGHT 2010 BY Mohammad Faizan Farooq FFQA DEC 2008 The definition of a liability forms an important element of the International Accounting Standards Boards Framework for the Preparation and Presentation of Financial Statements which, in turn, forms the basis for IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Required: Define a liability and describe the circumstances under which provisions should be recognised. Give two examples of how the definition of liabilities enhances the reliability of financial statements. (5 marks) On 1 October 2007, Promoil acquired a newly constructed oil platform at a cost of $30 million together with the right to extract oil from an offshore oilfield under a government licence. The terms of the licence are that Promoil will have to remove the platform (which will then have no value) and restore the sea bed to an environmentally satisfactory condition in 10 years time when the oil reserves have been exhausted. The estimated cost of this on 30 September 2017 will be $15 million. The present value of $1 receivable in 10 years at the appropriate discount rate for Promoil of 8% is $046. Required: (i) Explain and quantify how the oil platform should be treated in the financial statements of Promoil for the year ended 30 September 2008; (7 marks) (ii) Describe how your answer to (b)(i) would change if the government licence did not require an environmental clean up. (3 marks)
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