This obligation has a present value of $20m. The obligation needs to have arisen from a past event, rather than simply something which may or may not arise in the future. In this case, the provision should be included within the original cost of the asset, as this is directly attributable to the construction of that asset. The obligation could be a legal or contractual one, arising from a court case or some kind of contractual arrangement. Therefore any provision should only include items such as redundancies and closure costs. This relates to a potential inflow of economic resources which could come into the entity. On average, 10% need minor repairs, and 5% need major repairs. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want. Rey Co estimate that the damage will cost $400,000 to restore. The legal advisors believe that there is an 80% chance that the counter claim against the manufacturer is likely to succeed, and believe that Rey Co would win $8m. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. FREE Courses Blog. These are: These criteria will now be examined in further detail to see how they can be applied in practice. Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. Whilst this seems inconsistent, this demonstrates the asymmetry of prudence, that losses will be recorded earlier than potential gains. The second type of obligation is one called a constructive obligation. Rey Co could delay the work until 20X9, or sell the building. To address inconsistencies with other IFRSs. At 31 December 20X8, the legal advisors of Rey Co now believe that the $10m payment from the court case would be payable in one year. In reality a virtually certain inflow is unlikely. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. As part of obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at the end of its useful life. The global body for professional accountants, Can't find your location/region listed? As soon as an entity is aware that a contract is onerous, the full loss should be provided for as a liability in the statement of financial position. This site uses cookies. IAS 37 standard sets out the recognition, measurement and disclosure requirements of provisions, and it also deals with contingent assets and contingent liabilities. Therefore any provision should only include items such as redundancies and closure costs. A contingent liability is simply a disclosure note shown in the notes to the accounts. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. IAS 37 – Example (restructuring) – ACCA Financial Reporting (FR) Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. Restructuring costs associated with reorganising divisions provide two issues. Please visit our global website instead. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. A probable outflow simply means that it is more likely than not that the entity will have to pay money out. (8 marks) (a) (i) Importance of information concerning an… Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. The final criteria required is that there needs to be a probable outflow of economic resources. IFRS 2 Share-based Payment . Instead, a description of the event should be given to the users with an estimate of the potential financial effect. IAS 37 Provisions, Contingent Liabilities and Contingent Assets – ACCA (FA) lectures Spread the word Please spread the word so more students can benefit from our study materials. Careful attention must also be paid to the calculations involved in the recording of a provision, particularly those around long-term provisions and including them at present value. To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of $3m, with the impact of making the profit seem lower in the current period. Group accounting – part 2. This e-learning course is part of an e-learning series designed by PwC Academy Hungary which aims to provide a comprehensive overview of the application of IFRS (IAS) standards to finance and accounting experts who are already familiar with fundamental (local) accounting and reporting processes. Please visit our global website instead, Can't find your location listed? Rey Co gives a year’s warranty with all goods sold during the year. For example, in the case of an insurance claim where Rey Co can show they have cover. The second type of obligation is one called a constructive obligation. Candidates are required to learn the three key criteria for a provision, as they are likely to have to explain these in an exam. Even if the country has no legal regulations forcing Rey Co to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history. C2. In addition to this, the expected timing of when the event should be resolved should also be included. Note: Your answer should briefly set out the nature of financial capital in integrated reports. ACCA CIMA CAT DipIFR Search. 9. Past experience shows that Rey Co needs to do no repairs on 85% of the goods. The legal team think there is an 80% chance of this. This quiz will help you cover the theoretical and conceptual aspects of IAS 37 Provisions and Contingencies. The table below shows the treatment for an entity depending on the likelihood of an item happening. In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. If the employees have been informed, then an obligation exists and a provision must be made. In addition to this, the expected timing of when the event should be resolved should also be included. IAS 33 EPS - Number of shares. The second issue consideration is which costs should be included within the provision. In this case, Rey Co would include a provision for the $10m loss in liabilities. IFRS 10 Consolidated Financial Statements. In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. Whilst this seems inconsistent, this demonstrates the asymmetry of prudence, that losses will be recorded earlier than potential gains. Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. If the time value of money is material, generally if the potential outflow is payable in one year or more, the provision should be discounted to present value initially. Rey Co estimate that the damage will cost $400,000 to restore. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. To understand provisions better, let’s break down the definition of a liability in IAS 37: A liability is a present obligation arising from past event that is expected to be settled by an outflow of economic benefits from an entity. IAS 37 Provisions, Contingent Liabilities and Contingent Assets contains requirements on how to measure decommissioning, restoration and similar liabilities. 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