CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
A REVIEWER
CHAPTER 23
Provision
Existing liability of uncertain timing or uncertain
amount.
Essence = there is uncertainty about the timing
or amount of the future expenditures
N.B. It is the uncertainty that distinguishes
provision from other liabilities.
Liability = exists at the end of the reporting
period; but the
Amount = Indefinite or the date when the
obligation is due is also indefinite, and in some
cases, the payee cannot be identified or
determined.
N.B. Provision may be equivalent of an
estimated liability or a loss contingency that is
accrued because it is both probable and
measurable.
Recognition of Provision
(PAS 37, par. 14) Provision shall be recognized
as a liability in the financial statements under
the following conditions:
a. Entity has a present obligation, legal or
constructive, as a result of past event.
b. Probable that an outflow of resources
embodying economic benefits would be
required to settle the obligation.
c. Amount of the obligation cannot be
measured reliably.
Present Obligation
May be legal or constructive.
Obligation arising from a contract, legislation or
other operation of law.
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Constructive Obligation = Obligation derived
from an entity’s actions where:
a. Entity has indicated to other parties that it
will accept certain responsibilities by reason
of an established pattern of past practice,
published policy, or a sufficiently specific
current statement.
b. As a result, the entity has created a valid
expectation on the part of other parties that
it will discharge those responsibilities
N.B. Constructive obligation exists when the
entity from an established pattern of practice or
stated policy has created a valid expectation
that it will accept certain responsibilities.
Fast Event
Obligating Event = Past event that leads to a
present obligation
N.B. Accounting provision cannot be created in
anticipation of a future event. The event must
have already occurred which gives rise to the
legal or constructive obligation
Obligating Event = Event that creates a legal or
constructive obligation because the entity has
no realistic alternative but to settle the
obligation created by the event
This is the case where:
a. Settlement of the obligation can be enforced
by law
b. Event creates valid expectations on the part
of other parties that the entity will discharge
the obligation, as in the case of a constructive
obligation.
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A REVIEWER

Probable Outflow of Economic Benefits
For a provision to qualify for recognition = there
must be not only a present obligation but also a
probable outflow of resources embodying
economic benefits to settle the obligation.
Outflow of resources = regarded as probable if
the event is more likely than not to occur,
meaning, the probability that the event will
occur is greater than the probability that it will
not occur.
RULE OF THUMB:
Probable = more than 50% likely to occur.
Possible = 50% or less likely to occur
Remote = 10% or less likely to occur or very
slight occurrence
Best Estimate = amount that an entity would
rationally pay to settle the obligation at the end
of reporting period or to transfer it to a third
party at that time.
Single Obligation being measured = Individual
most likely outcome adjusted for the effect of
other possible outcomes may be the best
estimate.
Continuous range of possible outcomes and
each point in that range is as likely as any other
= Midpoint of range is used.
Provision being measured involves a large
population of items = obligation is estimated by
weighting all possible outcomes by their
associated possibilities.
Measurement Considerations

Reliable Estimate Following item are taken into consideration in

recognizing and measuring a provision:
(PAS 37, par. 25) Use of estimates is an essential
part of the preparation of financial statements a. Risks and uncertainties
and does not undermine their reliability.
b. Present value of obligation
Especially true in the case of provision because
c. Future events
by nature, a provision is more uncertain than
most items in the statement of financial d. Expected disposal of assets
position.
e. Reimbursements
Using a range of possible outcome = Entity
f. Changes in provision
would be able to make an estimate of the
obligation that is sufficiently reliable g. Use of provision
N.B. Where no reliable estimate can be made, h. Future operation losses
no liability is recognized.
i. Onerous contract

Measurement of Provisions
Amount recognized as a provision = Should be
the best estimate of the expenditure required
to settle the present obligation at the end of
reporting period.
(a) Risks and Uncertainties
Risks and uncertainties that inevitably surround
events and circumstances shall be taken into
account in reaching the best estimate of a
provision.

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N.B. Risk describes variability of outcome
Risk adjustment = may increase the amount at
which a liability is measured.
N.B. Any cash flows from disposal are treated
separately from the measurement of the
provision.

As prudence dictates, caution is needed in

making judgement under conditions of (e) Reimbursements
uncertainty so that income and assets are not
Reimbursement shall be recognized when it is
overstated, or expenses and liabilities are not
virtually certain that reimbursement would be
understated.
received if the entity settles the obligation.
N.B. Uncertainty does not justify the creation of
Shall be treated as a separate asset and not
excessive provision or a deliberate
netted against the estimated liability for the
overstatement of liabilities
provision.

N.B. Amount of reimbursement shall not exceed

(b) Present Value of Obligation the amount of the provision. However, in the
income statement, the expense relating to the
Effect of the time value of money is material =
provision may be presented net of the
amount of provision shall be the present value
reimbursement.
of the expenditure expected to settle the
obligations

N.B. Discount rate should be a pretax rate that (f) Changes in Provision
reflects the current market assessment of the
Provision = shall be reviewed at every end of
time value of money and the risk specific to the
the reporting period and adjusted to reflect the
liability
current best estimate.

Shall be reversed if it is no longer probable that

(c) Future Events
Future events that affect the amount required
to settle an obligation = reflected in the amount
of a provision where there is a sufficient
evidence that they will occur.
an outflow of economic benefits would be
required to settle the obligation
N.B. Where discounting is used, the carrying
amount of the provision increases each period
to reflect the passage of time

N.B. Such future events include new legislation

and changes in technology
(g) Use of Provision

Provision = shall be used only for expenditures

(d) Expected Disposal of Assets for which the provision was originally
recognized
Gains from expected disposal of assets = not be
taken into account in measuring a provision. Example:

Entity = shall recognize gain on disposal at the Provision for plant dismantlement cannot be
time of the disposal of the assets. used to absorb environmental pollution claims
or warranty payments.

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If an expenditure is charged against a provision
that was originally recognized for another
purpose, that would camouflage the impact of
two different events, thus distorting financial
performance and possibly constituting financial
reporting fraud.
(h) Future Operating Losses
Provision for operating losses = not recognized
because a past event creating a present
obligation has not occurred,
N.B. Provision shall not be recognized for future
operating losses
(i) Onerous Contract
Contract in which the unavoidable costs of
meeting the obligation under the contract
exceed the economic benefits expected to be
received under it.
Entity has an onerous contract = present
obligation under the contract shall be
recognized and measured as a provision
(PAS 37, par. 68) Unavoidable costs under a
contract represent the least net cost of existing
form the contract.
N.B. The lower amount between the cost of
fulfilling the contract and the compensation or
penalty arising from failure to fulfill the contract
is the least cost of exiting from the contract.
Examples of Provision
1. Warranties – recognized as a provision
because there is clear constructive obligation
arising from an obligating event which is the
sale of the product with warranty.
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2. Environmental Contamination – If an entity
has an environmental policy such that other
parties would expect the entity to clean up any
contamination, or if the entity has broken
current environmental legislation, then a
provision for environmental damage shall be
made.
The obligating event is the contamination of the
property which gives rise to constructive or
legal obligation.
Provision is recognized for the best estimate of
the cost of cleaning up the contamination.
3. Decommissioning or Abandonment Costs –
When an old entity initially purchases an oil
field, it is put under a legal obligation to
decommission the site at the end of the life. The
costs of abandonment or decommissioning shall
be recognized as a provision.
4. Court Case – After a wedding in the current
year, ten people died possibly as a result of
food poisoning from products sold by the entity.
Legal proceedings are started seeking damages
from the entity.
When the entity prepares the financial
statements for the current year, the lawyers
advise that owing to the developments in the
case, it is probable that the entity would be
found liable.
A provision is recognized for the best estimate
of the damages because there is a present
obligation.
5. Guarantee – In the current year, an entity
gives a guarantee of certain borrowings of
another entity. During the year, the financial
condition of the borrowing deteriorates and at
year-end, the borrower files a petition for
bankruptcy.
A provision is recognized for best estimate of
the guarantee obligation because there is legal
obligation arising from the guarantee.
 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
A REVIEWER

Contingent Liability Contingent Asset

PAS 37, Par. 10 (PAS 37, par. 10) Possible asset that arises from
past event and whose existence will be
(1) A Possible obligation that arises from past
confirmed only by the occurrence or
event and whose existence will be confirmed
nonoccurrence of one or more uncertain future
only by the occurrence or nonoccurrence of one
events not wholly within the control of the
or more uncertain future events not wholly
entity.
within the control of the entity
N.B. Shall not be recognized because this may
(2) A Present obligation that arises from past
result to recognition of income that may never
event but is not recognized because it is not
be realized. However, when the realization of
probable that an outflow of resources
income is virtually certain, the related asset is
embodying economic benefits will be required
no longer contingent asset, and its recognition
to settle the obligation or the amount of the
is appropriate
obligation cannot be measured reliably.
N.B.2. Contingent asset is only disclosed when it
is probable
Contingent Liability and Provision
Disclosure includes a brief description of the
(2) Contingent liability is a present obligation contingent asset and an estimate of its financial
effects.
Present obligation is either probable or
measurable but not both to be considered a N.B.3. If a contingent asset is only possible or
contingent liability. remote, no disclosure is required.

N.B. If the present obligation is probable and

the amount can be measured reliably, the
obligation is not a contingent liability but shall
be recognized as a provision.

Treatment of Contingent Liability

Shall not be recognized in the financial

statements but shall be disclosed only. The
required disclosures are:

a. Brief description of the nature of the

contingent liability

b. Estimate of its financial effects

c. Indication of the uncertainties that exists

d. Possibility of any reimbursement

N.B. If a contingent liability is remote, no

disclosure is necessary

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 CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS
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CHAPTER 25 a. Permanent Differences

Introduction Items of revenue and expense which are

included in either accounting income or
Deferred tax accounting = applicable to all
taxable income but will never be included in
entities, whether public or nonpublic entities.
the other.
Public Entity:
Pertain to nontaxable revenue and
a. Whose equity and debt securities are nondeductible expenses.
traded in a stock exchange or over-the-
Do not give rise to deferred tax asset and
counter market
liability because they have no future tax
b. Whose equity or debt securities are consequences.
registered with securities and exchange
Example:
commission in preparation for sale of the
securities 1. Interest Income on Deposits

2. Dividends Received

Accounting Income (Financial Income) 3. Life Insurance Premium

Net income for the period before deducting
income tax expense
The income appearing on the traditional income
statement and computed in accordance with
accounting standards.
 Entity is the beneficiary of a life
insurance policy on an officer or
employee, the premium paid by the
entity is not deductible as expense
for tax purposes but said premium is
an expense for financial reporting
purposes.

Taxable Income 4. Tax Penalties, surcharges and fines are

nondeductible.
Income for the period determined in
accordance with the rules established by the b. Temporary Differences
taxation authorities upon which income taxes
Items of income and expenses which are
are payable or recoverable.
included in both accounting income and
Income appearing on the income tax return and taxable income but at different time periods
computed ion accordance with the income tax
N.B. Gives rise either to a deferred tax liability
law.
or deferred tax asset.
May be defined also as the excess if taxable
revenue over tax deductible expense and
exemptions for the period as defined by the BIR.

Differences between Accounting and Taxable Deferred Tax Liability

Income

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(PAS 12, Par. 15) Shall be recognized for all (PAS 12, par. 24) Shall be recognized for all
taxable temporary differences deductible temporary differences and operating
loss carryforward when it is probable that
Amount of income tax payable in future periods
taxable income will be available against which
with respect to a taxable temporary difference
the deferred tax asset can be used.
Taxable temporary difference = temporary
Operating loss carryforward = excess of tax
difference that will result in future taxable
deductions over gross income in a year that
amount in determining taxable income of future
may be carried forward to reduce taxable
periods.
income in a future year.
N.B. Deferred tax liability arises when
N.B. A deferred tax asset is the deferred tax
accounting income is higher than taxable
consequence attributable to a future deductible
income because of future taxable amount.
amount and operating loss carryforward.

N.B.2 Arises when taxable income is higher than

Accounting Income Higher than Taxable Income accounting income because of future deductible
amount
Temporary differences that result in accounting
income higher than taxable income include the
following:
Taxable Income Higher than Accounting Income
1. Revenues and gains are included in
1. Revenue and gains are included in taxable
accounting income of the current period but
income of current period but are included in
are taxable in future periods.
accounting income of future periods.
Example:
Example:
Installment sale is included in accounting
Rent received in advance is taxable at the time
income at the time of sale and included in
of receipt but deferred in future periods for
taxable income when cash is collected in
accounting purposes.
future periods.
2. Expenses and losses are deducted from
2. Expenses and losses are deductible for tax
accounting income of current period but are
purposes in the current period but
deductible for tax purposes in future periods
deductible for accounting purposes in future
periods. Example:

a. Accelerated Depreciation for tax Doubtful accounts are deducted from

purposes and straight-line depreciation accounting income but are deductible for tax
for accounting purposes. purposes when proved worthless in future
period.
b. Prepaid expense has already been
deducted on a cash basis in determining
taxable income of the current period.

Deferred Tax Asset

Current Tax Liability and Current Tax Asset

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Current Tax Liability = current tax expense or

the amount of income tax actually payable.
Classified as current liability

Income tax for corporations is payable every

quarter (Income Tax Law)

Amount of tax already paid for the current

period exceeds the amount actually payable for
the period = excess is recognized as current tax
asset.

Current tax asset = prepaid income tax and shall

be classified as current asset.

N.B. Current tax liability or current tax asset

shall be measured using the tax rate that has
been enacted and effective at the end of the
reporting period

Measurement of Deferred Tax Asset or Liability

Shall be measured using the tax rate that has

been enacted by the end of the reporting
period and expected to apply to the period
when the asset is realized, or the liability is
settled.

Example:

Tax rate of 30% is applicable to the taxable year

2020. By December 31, 2020, a new tax law has
been enacted imposing a 25% tax rate effective
taxable year 2021.

Current tax liability or current tax asset is

measured at 30% but the deferred tax liability
or deferred tax asset is measured using the new
enacted tax rate of 25%.

(PAS 12, par. 70) Deferred tax liability is

presented as noncurrent liability and deferred
tax asset is presented as noncurrent asset.

N.B. Deferred tax asset or deferred tax liability

shall not be discounted.

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