PROVISIONS,

CONTINGENT LIABILITIES, AND CONTINGENT ASSETS

• Provision
o Liability of uncertain timing or amount
o Examples:
i. warranty obligations
ii. estimated liabilities on pending lawsuits
iii. provision for environmental damages
iv. provisions of decommissioning costs of an item of PPE
v. obligations caused by an entity’s policy to make refunds to customers
vi. obligations arising from guarantees
vii. provisions on onerous contracts
viii. provisions for restructuring costs
o Presented in the statement of financial position separately from other types of liabilities
o Recognition: (conditions)
i. Present obligation resulting from past event
ii. Probable that an outflow of resources embodying economic benefits will be required to settle the
obligation
iii. Amount of the obligation can be reliably estimated
o All provisions are contingent because they are of uncertain timing or amount
• Contingent liability
o A possible obligation whose existence will be confirmed only by the occurrence or non-occurrence of one
or more uncertain future events not wholly within the control of the entity
o A present obligation but
i. It is not probably that it will cause an outflow in its settlement;
ii. Its amount cannot be reliably estimated
o Are disclosed only, except when the possibility of an outflow of resources embodying economic benefits
is remote
• Contingent assets
o Are not recognized because they do not meet all the of the asset recognition criteria
o Include possible inflows of economic benefits from unplanned or unexpected events, such as claims that
an entity is seeking through legal processes where the outcome is uncertain
o Are disclosed only, if the inflow of economic benefits is probable; not recognized because they may result
to unrealized income
o If income is virtually certain (100% occurrence), the asset is recognized
• Measurement of the provision
Nature of the outflow Measurement basis
1. General rule Best estimate
2. Large population of Expected value
items (probability weighed
average)
3. Each possible Mid-point
outcome in a range is as
likely as any other
• Recording the provision
o Debit to expense or loss
o Credit to an estimated liability account
• Risk and uncertainties
o The estimates may be increased by a risk adjustment factor to provide an allowance for imprecision
inherent in estimates.
o This does not mean that the entity can make excessive provisions or can deliberately overstate liabilities.
• Present value

Prepared by: Moneia Brae E. Casas (BSMA II)

 o When the effect of time value of money is material, provisions should be discounted to their present values
using a current pre-tax discount rate
• Future events
o Future events are considered in estimating a provision only if there is objective evidence that supports
the anticipation.
o When a proposed new law has yet to be finalized, obligation arises only when it is virtually certain to be
enacted.
• Expected disposal of asset
o Gains from the expected disposal of assets shall not be taken into account in measuring a provision.
o Gains are recognized separately when the disposals occur.
• Reimbursements
o Reimbursements are considered only when their receipt is virtually certain.
o The reimbursement asset is presented in the statement of financial position separately from the provision
o In the statement of comprehensive income, the expense related to the provision may be presented net of
the reimbursement, which should not exceed the amount of the provision
• Changes in provisions
o Are accounted for prospectively by accruing an additional amount or by reversing a previously recognized
amount
• Use of provisions
o A provision is used only for the expenditure it was originally intended for
o Charging expenditure against a provision that is intended for another purpose is inappropriate as it would
conceal the impact of two different events
• Application of the recognition and measurement rules
o Future operating losses
§ No provision is recognized for future operating losses because they do not meet the definition of
a liability
o Onerous contracts
§ The provision recognized from an onerous contract reflects the least net cost of exiting from the
contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising
from failure to fulfill it
• Restructuring
o It is a program planned and controlled by management, and materially changes either:
1. The scope of a business undertaken by an entity
2. The manner in which that business is conducted

Examples:
1. Sale or termination of a line of business
2. Closure of business locations in a country or region or the relocation of business activities from
one country or region to another
3. Changes in management structure, for example, eliminating a layer of management
4. Fundamental reorganizations that have a material effect on the nature and focus of the entity’s
operations
o Measurement of restructuring provisions
Not included Included
1. Retraining or relocating continuing staff 1. Sale or termination of business

2. Marketing 2. The closure of business locations or the
relocation of business activities
3. Investment in new systems and
distribution networks 3. Changes in management structure

4. Future operating losses (unless related 4. Fundamental reorganizations that have
to an onerous contract material effect on the nature and focus
of the entity’s operations
Prepared by: Moneia Brae E. Casas (BSMA II)



o Considerations when applying the general recognition criteria:
5. Sale of operation • Accrue provision only if a binding sale agreement is
obtained on or before the end of the reporting period

• If binding sale agreement is obtained only after the end of
the reporting period, no provision shall be recognized, and
only a note disclosure shall be made for the non-adjusting
event

6. Closure or • Accrue only if a detailed formal plan is adopted and

reorganization announced publicly on or before the end of the reporting
period. A mere board decision to restructure is not enough

• If detailed plan is adopted or announced after the end of the
reporting period, no provision shall be recognized, and only
a note disclosure shall be made for the non-adjusting event
7. Restructuring • Accrue provision for terminating employees, closing
provision on facilities, and eliminating product lines only if announced at
acquisition acquisition and, then only if a detailed formal plan is
(merger) adopted within a short period of time after acquisition

8. Future operating • Provisions are not recognized for future operating losses,
losses even in a restructuring

• Accounting treatment for different cases
Case Accounting treatment
Liability for pending lawsuits, tax assessments, Recognize a provision if there is present obligation and the
government-imposed penalties, and the like outflow is both probable and estimable
Defective product causes injury to customers; Present obligation arises from injury caused to customers.
no lawsuits have yet been filed Provision is recognized if outflow is both probable and
estimable
Environmental damages Recognize a provision if the entity’s policy is to clean up even if
there is no legal requirement to do so
Restructuring by sale of an operation Recognize a provision only if a binding sale agreement is
obtained on or before the end of reporting period
Restructuring by closure or reorganization Recognize a provision only if a detailed formal plan is adopted
and announced publicly on or before the end of the reporting
period
Warranty, Premiums, and Refunds Recognize a provision at the point of sale if there is a legal or
constructive obligation
Guarantee for indebtedness of others Recognize a provision only when the liability for the guarantee
becomes probable
Offshore oil rig must be removed and sea bed Recognize a provision only when the oil rig is installed. The
must be restored provision is added to the cost of the asset
Onerous (loss-making) contract Recognize a provision if outflow is both probable and estimable
An entity must train its employees to increase No provision; there is no obligation to provide the training
productivity and efficiency
An entity has a self-insurance policy No provision until an actual loss is incurred
Major overhaul or repairs No provision; there is no obligation event, unless commitment
was made to a third party for the overhaul or repair

Prepared by: Moneia Brae E. Casas (BSMA II)
PROVISIONS, CONTINGENT LIABILITIES, AND CONTINGENT ASSETS
Problem and Solution

Problem
Slytherin Company is engaged in a restructuring activity in its accessories division. The controller and chief finance
officer are considering the following costs to accrue as part of the restructuring.
The entity has a long-term lease on one of the facilities related to the division. It is estimated that it will have
to pay a penalty of P3,000,000 to break the lease.
The entity estimates that the present value related to the payment on the lease contract is P5,500,000.
The entity’s allocation of overhead costs to other divisions will increase by P17,000,000 due to the
restructuring of the facilities.
Some employees will be shifted to other division within the entity and the cost of retraining the employees is
estimated to be at P22,000,000.
An outplacement firm has been hired by the entity to help in dealing with the number of terminations related
to the restructuring. It is estimated to cost P8,000,000.
Employee termination costs are estimated to be P30,000,000 and the entity believes that moving usable assets
from the accessories division to other divisions within the entity will cost P5,300,000.

Requirement: How much should be the total amount included in the restructuring provision?
Solution:
Penalty for lease termination P3,000,000
Cost of hiring an outplacement firm 8,000,000
Employee termination costs 30,000,000
Total restructuring provision 40,000,000




Reference: Financial Accounting Volume II 2019 Edition (Valix, Peralta, Valix)

Prepared by: Moneia Brae E. Casas (BSMA II)