INTERMEDIATE ACCOUNTING 3

CONTINGENT
LIABILITY
 NATIONAL UNIVERSITY
JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

CONTINGENT LIABILITY
INTERMEDIATE ACCOUNTING 3
PREPARED BY: Ventura, Kobe Christian B.

DISCLAIMER: This paper is prepared by bonafide NUJPIANS for A.Y. 2021-2022.

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CONTINGENT LIABILITY
• a possible obligation depending on whether some uncertain future event occurs, or
• a present obligation but payment is not probable, or the amount cannot be measured
reliably

TREATMENT OF CONTINGENT LIABILITY

• a contingent liability shall not be recognized in the financial statements but shall be
disclosed only.

PROVISION
• a liability of uncertain timing or amount
 NATIONAL UNIVERSITY
JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

TREATMENT OF PROVISION
RECOGNIZED IN THE STATEMENT OF FINANCIAL POSITION WHEN, AND ONLY
WHEN
• an enterprise has a present obligation (legal or constructive) as a result of past events.
• it is probable that an outflow of resources embodying economic benefits will be required to
be settle the obligations and.
• a reliable statement can be made of the amount of the obligation

MEASUREMENT OF PROVISION
1. Best estimate – The amount recognized as a provision should be the best estimate of
the expenditure required to settle the obligation at the end of reporting period.
2. Most likely outcome – If a single obligation is being measured, the amount to be
recognized as a liability is the most likely outcome
3. Midpoint of the range – The provision being measured involves large population of
items; the obligation is estimated by weighing all possible outcomes by their
associated possibilities.
4. Present Value of Expenditures – Where the effect of time value of money is
material, the amount should be the present value of the expenditures expected to be
required to settle the obligation.
5. Actual Settlement – The amount shown in the statement of financial position

The Following illustrates the principles discussed

CASE 1. In August 2020, ABS Corporation filed a suit against HOR Company alleging
violation of labor laws and it is seeking payment for damages of P10,000,000. HOR
disclaims the charges and legal counsel advises that as of date of the issuance of HOR
Company’s financial statements, it is probable that the enterprise will not be found liable.
No provision is recognized, because based on the data available as of the financial statement
date, there is no obligation as a result of past events. The matter is disclosed as a contingent
liability unless the probability of any outflow is regarded as remote.
CASE 2. Lopez Mining Company operates in a municipality where there is no environmental
legislation. However, the company has a widely published policy in which it undertakes to
clean up all contamination it causes. As of date the issuance of its 2020 financial statements,
a reasonable estimate of the cost of this clean up related to 2020 operations is P6,000,000
A provision is recognized for the estimated amount of the costs of the clean-up, which is
P6,000,000. The obligating event is one of the constructive obligations. The entry for the
recognition of provision is:
Environmental Clean-Up Expense 6,000,000
Provision for Environmental Clean-Up 6,000,000
 NATIONAL UNIVERSITY
JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

CASE 3. As a result of uninsured unfortunate incident during 2020, personal injury case for
P1,000,000 has been filed against 3D Company. It is the judgement of the company’s legal
counsel that an unfavorable decision will result in a loss ranging from P500,000 to P900,000.
The lawyer believes that the most reasonable estimate is P700,000
A provision is recognized for the best estimate of the obligation: The best estimate is the most
likely outcome, which is P700,000. The entry for the provision is
Loss from Accident 700,000
Provision for Damages 700,000
Additional possible obligation of P200,000 (the difference between recorded amount of
P700,000 and the highest in the range of estimated amounts of P900,000) is to be disclosed in
the notes to the financial statements.
CASE 4. KCV Company sells imported products with a warranty under which customers are
covered for the cost of any manufacturing defects that become apparent within first year after
purchase. If minor defects were detected in all products sold, repair costs of P3 million would
result.
If major defects were detected in all products sold, repair costs of P7 million would result.
The enterprise’s experience and future expectations indicate 70% of the goods sold have no
defects, 20% of the goods sold have minor defects, and 10% of the goods sold have major
defects.
It is probable that the sale of defective merchandise will result in an outflow of economic
benefits. Thus, the sale created an obligation. The best estimate of the obligation is derived by
weighing all possible outcomes by their associated probabilities. Thus, the provision shall be
measured as follows:
No defects P0×70% P0
Minor defects P3m×20% 600,000
Major defects P7m×10%. 700,000
Amount Provision P1,300,000

CASE 5. CBN is charged with multiple lawsuits because of an accident that happened in July
2020, causing death of about 60 persons and sever injury to about 20 persons because of
stampede in a marketing program it was airing through Channel 2 on July 10, 2020. Based on
similar incidents suffered by other entities, CBN’s legal counsels are of the opinion that it is
probable that CBN would be found liable for the incident. As of the date of the issuance of
the 2020 financial statements, a reasonable estimate of the obligation is between P20,000,000
to P25,000,000. Each point within the range is as likely as any other.

The provision being measured above involves a large population of items and there is a
continuous range of possible outcomes. There is no better estimate in the range, and each
point within that range is as likely as any other point. Thus, the provision shall be measured
at the midpoint of the range. The midpoint is the simple average or the mean, thus
P45,000,000 (P20,000,000 + P25,000,000) divided by 2 equals P22,500,000
 NATIONAL UNIVERSITY
JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

The entry to set up the provision is

Loss from Damages P22,500,000

Provision for Damages P22,500,000

SUMMARY ANALYSIS OF PROVISIONS AND CONTINGENT LIABILITIES

PROVISIONS AND CONTINGENCIES DISPOSITION

There is a present obligation that probably A provision is recognized

requires an outflow of resources that can be
measured reliably
There is a present obligation that probably
requires an outflow of resources, but the
amount cannot be measured reliably
There is a possible obligation or a present
obligation that may, but probably will not,
require an outflow of resources
There is a possible obligation or a present
obligation where the likelihood of an outflow
of resources is remote
Disclosures are required for the provision
No provision is required
Disclosures are required for the contingent
liability
No provision is recognized
Disclosures are required for the contingent
liability
No provision is recognized
No disclosure is required

REFERENCES:
Robles, N., Empleo, P., 2016. The Intermediate Accounting. 2016 ed.
Robles, N., 2016. Practical Accounting 1. 2016 ed.
Valix, C., Peralta, F., Valix, C., 2018. Conceptual Framework and Accounting
Standards. First Edition