Rey Co gives a year’s warranty with all goods sold during the year. If the item is made up of a number of items, such as a warranty provision for repairing goods, the expected value should be calculated using the probability of all events happening. Clearly this is not good for the users of the financial statements, as they would have been manipulated and given a false impression of the performance of the business. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. The exception to this is if an entity creates an obligation for future costs due to the construction of a non-current asset. IAS 37 Provisions, Contingent Liabilities and Contingent Assets contains requirements on how to measure decommissioning, restoration and similar liabilities. IAS 37 requires a provision be recognised when all of the following apply: an entity has a present obligation (legal or constructive) as a result of a past event. He also knows that the profit target will be set at $14m in the next year. 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. Whilst this seems inconsistent, this demonstrates the asymmetry of prudence, that losses will be recorded earlier than potential gains. 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. Therefore any provision should only include items such as redundancies and closure costs. IAS 37 – Measurement (present value) – ACCA Financial Reporting (FR) C2. Restructuring costs associated with reorganising divisions provide two issues. ACCA BT F1 MA F2 FA F3 LW F4 Eng PM F5 TX F6 UK FR F7 AA F8 FM F9 SBL SBR INT SBR UK AFM P4 APM P5 ATX P6 UK AAA P7 INT AAA P7 UK. So far, all of the items considered in this article have involved the provision being recorded as a liability with the debit being shown as an expense in the statement of profit or loss. 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 … Similar to the concept of a contingent liability is the concept of a contingent asset. Rey Co could not provide for any possible claims which may arise from injuries in the future. IAS 37 Provisions, Contingent Liabilities and Contingent Assets outlines the accounting for provisions, together with contingent assets and contingent liabilities. The obligation could be a legal or contractual one, arising from a court case or some kind of contractual arrangement. Rey Co estimate that the damage will cost $400,000 to restore. Which of the following statements about the requirements of IAS 37 Provisions, contingent liabilities and contingent assets are correct? On average, 10% need minor repairs, and 5% need major repairs. Please visit our global website instead. This is where a company establishes an expectation through an established course of past practice. This article will consider the aims of the standard, followed by the key specific criteria which must be met for a provision to be recognised. A probable outflow simply means that it is more likely than not that the entity will have to pay money out. In an exam, it is unlikely that there will not be a reliable estimate. The key here is whether the restructuring has been announced to the affected employees. They believe there is a 10% chance of having to pay $12m, and a 10% chance of paying nothing. IFRS 2 Share-based Payment . Here, the provision would be measured at $60k. According to IAS 37, 3 criteria are required to be met before a provision can be recognised. A contingent asset should be disclosed by note if an inflow of economic benefits is probable. The first is to assess whether an obligation exists at the reporting date. IAS 37 requires an entity to record an obligation as a liability only if it is probable (i.e. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. 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. IAS 19 Employee Benefits. Therefore there is no present obligation to incur the costs associated with this. The table below shows the treatment for an entity depending on the likelihood of an item happening. Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. These costsshould exclude any costs associated with any continuing activities. Rey Co would have to provide for a potential legal case arising from an employee who was injured at work in 20X8 due to faulty equipment. Rey Co has a consistent history of honouring this policy. In reality a virtually certain inflow is unlikely. The expected cost of minor repairs would be $10k (10% of $100k) and the expected costs of major repairs is $50k (5% of $1m). Even though there is a similar likelihood that Rey Co would win the counterclaim, this is a probably inflow and therefore only a contingent asset can be recorded. Additionally, there is no onerous contract in this scenario. Free sign up Sign In. The expected cost of minor repairs would be $10k (10% of $100k) and the expected costs of major repairs is $50k (5% of $1m). ACCA P2 Provisions, contingent assets and liabilities (IAS 37) Free lectures for the ACCA P2 Corporate Reporting Exams The second type of obligation is one called a constructive obligation. 1. This will be disclosed in the notes to the financial statements rather than being recorded as an asset in the statement of financial position. Even though there is a similar likelihood that Rey Co would win the counterclaim, this is a probably inflow and therefore only a contingent asset can be recorded. 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. In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. Again, a description of the event should be recorded in addition to any potential amount related to this. IAS 33 Rights Issue. the entity has a present obligation. 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. 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. So far, all of the items considered in this article have involved the provision being recorded as a liability with the debit being shown as an expense in the statement of profit or loss. Here, the provision would be measured at $60k. IAS 37 – provisions and contingent liabilities – ACCA Financial Reporting (FR) For example, in the case of an insurance claim where Rey Co can show they have cover. Written by a member of the Financial Reporting examining team, Virtual classroom support for learning partners, IAS 37 – Provisions, contingent liabilities and contingent assets, There needs to be a present obligation from past event. The second issue consideration is which costs should be included within the provision. Similarly, if Rey Co has to pay to install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8, so no provision is required. ACCA CIMA CAT DipIFR Search. Finally, it will examine some specific issues which are often assessed in relation to the standard. IAS 37 Provisions Contingent Liabilities and Contingent Assets Overview. For some ACCA candidates, specific IFRS® standards are more favoured than others. This is because the event arose in 20X8 which could lead to an obligation. C3. Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. There is no double entry recorded in respect of this. This obligation has a present value of $20m. IAS 37 full text Outlines the accounting for: (IAS 37 definition) Provisions ; is a liability with uncertain timing or amount. 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. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. The key difference is that a contingent asset is only recorded if there is a probable future inflow, rather than a possible one. 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. Restructuring costs associated with reorganising divisions provide two issues. Rey Co could not provide for any possible claims which may arise from injuries in the future. Then in the next year, the chief accountant could reverse this provision, by debiting the liability and crediting the profit or loss. 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. Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. FREE Courses Blog. During 20X8, Rey Co opened a new factory, leading to some environmental damage. The legal team think there is an 80% chance of this. The unwinding of this discount would be recorded in the statement of profit or loss as a finance cost. He also knows that the profit target will be set at $14m in the next year. In this case, Rey Co would provide $10m, being the most likely outcome. However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. This quiz will help you cover the theoretical and conceptual aspects of IAS 37 Provisions and Contingencies. Over the useful life of the asset, the $170m will be depreciated. IAS 27 Separate Financial Statements. The second issue consideration is which costs should be included within the provision. Subsequently, the discount on this provision would be unwound over time, to record the provision at the actual amount payable. In this situation, a contingent liability would be reported. Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. IAS 37 sets rules for measurement of provisions and discusses several factors to take into account in reaching the best estimate of provision: Risk and uncertainties, Present value, Future events, Expected disposals of assets. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery. IAS® 37 appears to be less popular than other standards because, usually, answers to Financial Reporting (FR) questions required a balanced discussion of whether criteria are met, as opposed to calculating numbers. These costsshould exclude any costs associated with any continuing activities. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Quiz Free IFRS Quizzes IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Quiz ) , () ) Previous Lesson. Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. The final criteria required is that there needs to be a probable outflow of economic resources. According to IAS 37, 3 criteria are required to be met before a provision can be recognised. Comments on the proposed changes are re… Group accounting – part 1. Clearly this is not good for the users of the financial statements, as they would have been manipulated and given a false impression of the performance of the business. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 2017 - 07 5 In the Notes to the financial statement: (d) Unless the possibility of any outflow in settlement is remote, an entity shall disclose for each class of contingent liability at the end of the financial reporting period … IAS 37 Provisions, Contingent Liabilities and Contingent Assets, excludes from its scope contracts which are executory in nature, and therefore prevents the recognition of a liability. Therefore there cannot be included in the financial statemets. Most candidates are able to spot this in exams, identifying the presence of a potential obligation of this type. EPS as a performance measure. In summary, IAS 37 is a key standard for FR candidates. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. The key difference is that a contingent asset is only recorded if there is a probable future inflow, rather than a possible one. For some ACCA candidates, specific IFRS® standards are more favoured than others. The changes proposed in ED/2018/2 Onerous Contracts — Cost of Ful­fill­ing a Contract (Proposed amend­ments to IAS 37) 1. specify that the ‘cost of ful­fill­ing’ a contract in paragraph 68 of IAS 37 comprises the ‘costs that relate directly to the contract’; and 2. provide examples of costs that do, and do not, relate directly to a contract to provide goods or services. If it appears that there is a possible outflow then no provision is recorded. 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. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. A contingent liability is simply a disclosure note shown in the notes to the accounts. 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. All subject exam questions. There is no specific list of what % likelihood is required for an outflow to be probable. Rey Co gives a year’s warranty with all goods sold during the year. Other candidates may calculate an expected value based on the various probabilities. In addition to this, the expected timing of when the event should be resolved should also be included. with a … However, IAS 37 is often a key standard in FR exams, and candidates must be prepared to wrestle with applying the criteria. These are: These criteria will now be examined in further detail to see how they can be applied in practice. The global body for professional accountants, Can't find your location/region listed? ... 8:54. It will not be uncommon to take the $12m, thinking that the worst-case scenario should be provided for. Here, Rey Co would capitalise the $170m as part of property, plant and equipment. Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. Rey Co would have to provide for a potential legal case arising from an employee who was injured at work in 20X8 due to faulty equipment. IAS 10 Events After The Reporting Period. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. ACCA F7 Video Lectures 2017 ACCA F7 Video Lectures 2017 Welcome to you all, now… Very Important Examiner Tips for PM, FR, AA and FM Examiner tips for PM PM exam sitters should remember to… Latest ACCA DipIFR Book and Exam Kit 2019 Latest ACCA DipIFR Book and … Provisions from past papers in ACCA FR (F7). In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. Rey Co constructed an oil platform in the sea on 1 January 20X8 at a cost of $150m. IAS 33 Bonus issue. The obligation needs to have arisen from a past event, rather than simply something which may or may not arise in the future. 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. The definition of a provision is key to the standard. IAS 37 sets out how to account for the credit risk of the entity IAS 37 does not give any guidance on non-performance risk by the entity In the case of IAS 37, the risk adjustment would measure the amount that it would cost to be free of risk Several existing IFRSs specify the types of costs that should be included in measuring an item. Over the useful life of the asset, the $170m will be depreciated. (8 marks) (a) (i) Importance of information concerning an… IFRS 3 Business Combinations . The legal team think there is an 80% chance of this. In addition to this, the discount on the provision will be unwound and the provision increased each year. The key here is whether the restructuring has been announced to the affected employees. IFRS 11 Joint Arrangements Here, Rey Co would capitalise the $170m as part of property, plant and equipment. Please visit our global website instead. This relates to a potential inflow of economic resources which could come into the entity. This quiz is a sample of our larger question bank of 50+ questions on IAS 37. The final criteria required is that there needs to be a probable outflow of economic resources. The IASB is likely to wait until the publication of the Conceptual Framework in 2016 before any … Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. For example, let’s take a fictional company, Rey Co. At the start of the year, Rey Co sets a profit target of $10m for the year ended 31 December 20X8. This will be disclosed in the notes to the financial statements rather than being recorded as an asset in the statement of financial position. C2. The table below shows the treatment for an entity depending on the likelihood of an item happening. In addition to this, the expected timing of when the event should be resolved should also be included. It can be seen here that Rey Co could only recognise an asset from a potential inflow if it is virtually certain. Again, a description of the event should be recorded in addition to any potential amount related to this. Rey Co has a cost of capital of 10%. In reality a virtually certain inflow is unlikely. ACCA CIMA CPD FIA (ACCA) AAT. 10. This article will consider the aims of the standard, followed by the key specific criteria which must be met for a provision to be recognised. Rey Co has received legal advice that the most likely outcome of the court case from the employee is that they will lose the case and have to pay $10m. This site uses cookies. 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 enable users to understand their nature, timing and amount. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Candidates are required to learn the three key criteria for a provision, as they are likely to have to explain these in an exam. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. more than 50% likely) that the obligation will result in an outflow of … Rey Co has received legal advice that the most likely outcome of the court case from the employee is that they will lose the case and have to pay $10m. Past experience shows that Rey Co needs to do no repairs on 85% of the goods. During this training session the participants will obtain a comprehensive understanding of the detailed requirements of these standards. This rule has two parts, first the type of obligation, and second, the requirement for it to come from a past event (something must have already have  happened to create the obligation). Finally, it will examine some specific issues which are often assessed in relation to the standard. Most candidates are able to spot this in exams, identifying the presence of a potential obligation of this type. Rey Co has a consistent history of honouring this policy. That is because there is no past event which has created the obligation. Rey Co has a cost of capital of 10%. In other words, if there is no past event, then there is no liability and no provision should be recognized. Rey Co estimate that the damage will cost $400,000 to restore. Rey Co has a published environmental policy. This relates to a potential inflow of economic resources which could come into the entity. Written by a member of the Financial Reporting examining team, Virtual classroom support for learning partners, IAS 37 – Provisions, contingent liabilities and contingent assets, There needs to be a present obligation from past event. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. Rey Co’s manufacturing manager has calculated that if minor repairs were needed on all goods it would cost $100,000, and major repairs on all goods would cost $1m. In summary, IAS 37 is a key standard for FR candidates. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. Group accounting – part 2. In this case, Rey Co would include a provision for the $10m loss in liabilities. The chief accountant of Rey Co has reviewed the profit to date and realises they are likely to achieve profits of $13m. probable ( >50% ) outflow of resources. In an exam, it is unlikely that there will not be a reliable estimate. The first is to assess whether an obligation exists at the reporting date. Then in the next year, the chief accountant could reverse this provision, by debiting the liability and crediting the profit or loss. 7:18. However, IAS 37 is often a key standard in FR exams, and candidates must be prepared to wrestle with applying the criteria. C3. This is where IAS 37 is used to ensure that companies report only those provisions that meet certain criteria. The second type of obligation is one called a constructive obligation. 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. IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets. Past experience shows that Rey Co needs to do no repairs on 85% of the goods. IAS® 37 appears to be less popular than other standards because, usually, answers to Financial Reporting (FR) questions required a balanced discussion of whether criteria are met, as opposed to calculating numbers. Standard also deals with reimbursements of provisions by another party, changes in provisions and use of provisions. To address inconsistencies with other IFRSs. 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. This is effectively an attempt to move $3m profit from the current year into the next period. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. (a) (i) Discuss why the information about the capital of a company is important to investors, setting out the nature of the published information available to investors about a company’s capital. If it appears that there is a possible outflow then no provision is recorded. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. ... ACCA … On average, 10% need minor repairs, and 5% need major repairs. 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. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. For example, in the case of an insurance claim where Rey Co can show they have cover. This rule has two parts, first the type of obligation, and second, the requirement for it to come from a past event (something must have already have  happened to create the obligation). 6:22. Likewise it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. This is where a company establishes an expectation through an established course of past practice. Other candidates may calculate an expected value based on the various probabilities. The accountant knows that if Rey Co  reports a profit of $13m, directors will not get any more of a bonus than if they reported $10m. 2. ... 37. Likewise it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. IAS 33 EPS - Number of shares. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. IAS 37 – Provisions, contingent liabilities and contingent assets For some ACCA candidates, specific IFRS® standards are more favoured than others. IFRS 10 Consolidated Financial Statements. 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. A probable outflow simply means that it is more likely than not that the entity will have to pay money out. Free sign up Sign In. This obligation has a present value of $20m. The global body for professional accountants, Can't find your location/region listed? Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. If the employees have not been informed, then the company could change its mind. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. FREE Courses Blog. Therefore there is no present obligation to incur the costs associated with this. Register; Log In; CPD IAS 37 - Provisions, Contingent Liabilities and Assets ... 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