GROUP NAME

GROUP MEMBERS

MOHSIN MUMTAZABDUL QAYYUMMUHAMMAD ISHFAQADNAN SULEMAN SADDAM HUSSAIN

PROVISIONS,CONTIGENT LIABILITIES AND CONTIGENT ASSETS

IAS 37

What is a provision? A provision is a liability of uncertain

timing or amount. A liability is a present obligation of

the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Why an accounting standard is necessary on provisions

Provisions were often recognised as a result of an intention to make expenditure, rather than an obligation to do so.

Several items could be aggregated into one large provision that was reported as an exceptional item (the ‘big bath’).

Inadequate disclosure meant that in some cases it was difficult to ascertain the significance of the provisions and any movements in the year.

OBJECTIVE OF IAS 37

The objective of IAS 37 Provisions, contingent liabilities and contingent assets is to ensure that:

Appropriate recognition criteria an measurement bases are applied to provisions, contingent liabilities and contingent assets

Sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.

Recognition of a provision

A provision should be recognised when:

If any one of these conditions is not met, no provision may be recognised.

An entity has a present obligation (legal or constructive) as a result of a past event

It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and

A reliable estimate can be made of the amount of the obligation.

MUHAMMAD ISHFAQPRESENTED BY

Obligations

A provision may be necessary as a result of

A legal or A constructive obligation.Legal obligation A legal obligation is an obligation

that derives from: A contract Legislation Other operation of law.

Constructive obligation

A constructive obligation is an obligation that derives from an entity’s actions where:

By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities, and

As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

Example

A retail store has a policy of refunding purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.

Should a provision be made at the year end?

Measuring provisions

The amount recognised as a provision should be:

A realistic estimate A prudent estimate of the expenditure

needed to settle the obligation existing at the reporting date

Discounted whenever the effect of this is material.

ABDUL QAYYUMPRESENTED BY

Methods of measuring uncertainties

Methods of measuring uncertainties include:

Weighting the cost of all probable outcomes according to their probabilities (‘expected value’)

Considering a range of possible outcomes.

Example

An entity sells goods with a warranty covering customers for the cost of repairs of any defects that are discovered within the first two months after purchase. Past experience suggests that 88% of the goods sold will have no defects, 7% will have minor defects and 5% will have major defects. If minor defects were detected in all products sold, the cost of repairs would be $24,000; if major defects were detected in all products sold, the cost would be $200,000.

What amount of provision should

EXAMPLE

An entity has to rectify a serious fault in an item of plant that it has constructed for a customer. The most likely outcome is that the repair will succeed at the first attempt at a cost of $400,000, but there is a significant chance that a further attempt will be necessary, increasing the total cost to $500,000.

Future operating losses No provision may be made for future

operating losses because they arise in the future and therefore do not meet the criterion of a liability.

Onerous contracts An onerous contract is a contract in which

the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

Environmental provisions

A provision will be made for future environmental costs if there is either a legal or constructive obligation to carry out the work

This will be discounted to present value at a pretax market rate.

ADNAN SULEMAN PRESENTED BY

Restructuring provisions

A restructuring is a programme that is planned and controlled by management, and materially changes either:

The scope of a business undertaken by an entity, or The manner in which that business is conducted. A provision may only be made if: A detailed, formal and approved plan exists The plan has been announced to those affected. The provision should: Include direct expenditure arising from restructuring Exclude costs associated with ongoing activities.

Contingent liabilities

A contingent liability is: A possible obligation that arises from past events

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, or

A present obligation that arises from past events but is not recognised because:

– it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or

– the amount of the obligation cannot be measured with sufficient reliability.

Contingent assets

A contingent asset is a possible asset that arises from past events 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.

SADDAM HUSSAIN PRESENTED BY

Accounting for contingent liabilities

Contingent liabilities: Should not be recognised in the

statement of financial position itself Should be disclosed in a note unless

the possibility of a transfer of economic benefits is remote.

Accounting for contingent assets

Contingent assets should not generally be recognised, but if the possibility of inflows of economic benefits is probable, they should be disclosed.

If a gain is virtually certain, it falls within the definition of an asset and should be recognised as such, not as a contingent asset.

Summary

Degree of probability of anoutflow/inflow of resources

Liability Asset

Virtually certain Provide Recognize

Probable Provide Disclose bynote

Possible Disclose by note

No disclosure

Remote No disclosure

No disclosure

Disclosure of contingencies

The principal disclosure requirements regarding contingencies are:

The nature of the contingency The uncertainties expected to affect

the ultimate outcome An estimate of the potential financial

effect.