Posted by whatheheckaboom ⋅ ⋅ 1 Comment
Applicable Standard
- IAS 37: Provisions, Contingent Liabilities and Contingent Assets
Provisions
Definitions
- Liability
- Present obligation as a result of past events
- Expected to result in an outflow of economic benefits
- Reliable estimate can be made of the amount
- Provision
- Liability of uncertain timing or amount
Recognition Criteria for a Provision
- Present obligation (legal or constructive) as a result of past events
- Note that for an environmental provision can only be recognised if the environment damage has already happened.
- Probable (> 50% probability)
- Reliable estimate can be made of the amount
Accounting Treatment of Provisions
- Increase in provisions is charged to Income Statement, and recognised in the Balance Sheet
- Future movements in provision is recorded in Income Statement.
- For provisions that are PV-ed, the provision increases each year as the discount is unwound. The discount that is unwound (i.e. the increase in liability) is recorded as a Finance Charge in the Income Statement. Example:
- Expected outflow of $110 at end of year 1, and outflow of $121 at end of year 2.
- At time 0
- Initial value = PV at 10% discount rate = 110/1.1 + 121/(1.1^2) = 100 + 100 = 200.
- Initial recognition, Dr Provision (Income Statement), Cr Provision (Balance Sheet) with 200.
- 1 year later
- Finance charge = Interest rate * Provision value = 10% * 200 = 20.
- Dr Finance Charge (Income Statement), Cr Provision (Balance Sheet) with 20.
- Outflow of 110, so Cr Provision (Income Statement),Dr Provision (Balance Sheet) with 110.
- Closing Provision value = 200 + 20 – 110 = 110.
- 2 years later
- Finance charge = Interest rate * Provision value = 10% * 110 = 11.
- Dr Finance Charge (Income Statement), Cr Provision (Balance Sheet) with 11.
- Outflow of 121, so Cr Provision (Income Statement), Dr Provision (Balance Sheet) with 121.
- Closing Provision value = 110 + 11 – 121 = 0.
- Special case: Compulsory costs related to Non-Current Assets
- E.g. clean up costs at the end of the asset’s life
- Instead of debiting Income Statement, the Non-Current Assets (in Assets) is debited, i.e. the cost of the asset increases. Hence the clean-up cost is capitalized into the cost of the asset.
- Accounting entries
- Dr Non-Current Assets (Balance Sheet)
- Cr Provision (Balance Sheet)
- The non-current asset is then depreciated per normal.
- The Finance Charge affects the Provision account, not the Non-Current Asset account.
Valuation of Provisions
- For a single obligation, best estimate of most likely outcome.
- For a large number of obligations, calculate the final expected value of the net obligation.
- If time value of money is material, provisions should be PV-ed using apre-tax market ratethat reflects the risk of the liability.
Contingent Liabilities
Definition
- Possible obligation that arises from past events
- Occurrence not wholly within the control of the entity.
- Either not probable (<= 50% probability) or amount cannot be measured with sufficient reliability
Accounting Treatment
- Not recognised in Balance Sheet or recorded in the ledger accounts.
- If the probability is ‘possible’, should be disclosed in the notes
- If the probability is ‘remote’, can be ignored.
Contingent Assets
Definition
- Same as contingent liability but an asset instead.
Accounting Treatment
- If the probability is ‘probable’, should be disclosed in the notes [note that this is stricter than for contingent liabilities. For contingent assets, it still cannot be disclosed when it is ‘possible’, only when it is ‘probable’]
- If the probability is ‘possible’ or ‘remote’, can be ignored.
- If the probability is ‘virtually certain’, it should be recognised as an asset.
-END-
Discussion
One thought on “Accounting for Provisions, Contingent Liabilities and Contingent Assets (IAS37)”
What should I entry if the entity is in a litigation for something, and it is probable that the entity will lose the case?
Posted by YuRiz | February 13, 2017, 7:49 am
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