MFRS 137: PROVISIONS, CONTINGENT LIABILITIES AND

CONTINGENT ASSETS

Learning objectives:

 Define provisions.
 Define contingent liability.
 Distinguish between provision and contingent liability.
 Explain the difference between provision and liability.
 Explain the recognition of provision that give rise to liability.
 Explain the accounting treatment for provision and contingent liability.
 Define contingent assets.
 Explain the recognition of contingent liability and contingent asset
 Explain the accounting treatment for contingent assets, onerous contract, future
operating losses and restructuring (Theory only and will not be tested in the final
exam)
 Explain the disclosure requirement
 MPERS

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OVERVIEW OF MFRS 137

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1. INTRODUCTION
 Accounting for provisions and contingencies is rather problematic due to the
increased level of uncertainty.
 The key issues include:
o Whether a provision or contingency should be recognised
o If it is recognised at what amount it should be recorded.
 Certain conditions may exist at the end of the reporting period which may affect the
financial position of the reporting period.
 The outcome and amount, however may not be conclusive and be surrounded by
uncertainties
 Where the uncertainties are clarified BEFORE the financial statements are
authorized for issue, the figures can be adjusted as adjusting events after the
balance sheet date.
 However, if not possible then :  make a provisions
disclose contingencies in notes to accounts

2. MFRS 138 : PPROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

 Objectives
o aims to ensure that:
 Appropriate recognition criteria and measurement bases are applied
to provisions, contingent assets and contingent liabilities; and
 Sufficient information is disclosed in the notes to the financial
statements to enable users to understand their nature, timing and
amount.

 Scope
o This standard has broad scope but there are 2 limited exceptions:

Executory contracts Executory contracts are contracts under which neither

except where the party has performed any of its obligations or both parties
contract is onerous. have partially performed their obligations to an equal
extent. For example, an unfulfilled order for the purchase
of goods, where at the end of the reporting period, the
goods have neither been delivered nor paid for.
Where the accounting For example, construction contracts (MFRS111), income
treatment is covered taxes (MFRS112), leases (MFRS117), employee benefits
by another accounting (MFRS119), insurance contracts (MFRS4), business
standards. combination.

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3. PROVISION
 A provision is a liability of uncertain timing or amount or both
 Liability – present obligation of the enterprise arising from past events, the settlement
of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits
 The important aspect of MFRS137 is to ensure that provisions are only recognised
where there are valid grounds for doing so.

4. RELATIONSHIP BETWEEN PROVISIONS AND CONTINGENT LIABILITIES

 Provisions are recognized as liabilities (assuming that a reliable estimate can be
made) because they ARE present obligations and IT IS probable that an outflow of
resources embodying economic benefits will be required to settle the obligations
 There are some provisions but NOT provisions under MFRS137:
o Provision for depreciation (Accumulated depreciation)
o Provision for doubtful debts (Allowance for doubtful debts)
 A liability that does not meet the recognition criteria of a provision is a contingent
liability.

5. DIFFERENCE BETWEEN PROVISION AND OTHER LIABILTIES

 Provisions can be distinguished from other liabilities such as trade payables and
accruals because there is uncertainty about the timing or amount of the future
expenditure required in settlement.
o trade payables are liabilities to pay for goods or services that have been
received or supplied and have been invoiced or formally agreed with the
supplier; and
o accruals are liabilities to pay for goods or services that have been received or
supplied but have not been paid, invoiced or formally agreed with the
supplier, including amounts due to employees (for example, amounts relating
to accrued vacation pay).
 The uncertainty is generally much less than for provisions.
 Accruals are often reported as part of trade and other payables, whereas provisions
are reported separately.

6. RECOGNITION

 Recognised as liability and make provision when:

1. An enterprise has a present obligation(legal or constructive) as result of past event

2. It is probable that outflow of resources embodying economic benefits will be
required to settle the obligations
3. A reliable estimate can be made of the amount of the obligation. If no reliable
estimate can be made then the liability is not accrued but disclosed as a contingent
liability.

 If one or more of these criteria is not met, a provision is not recognised.

 Overview of recognition criteria:

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 Present obligation
Definition: an obligating event arise from the a past event

Example 1:
Company X carries out quarrying activities. A condition of the planning consent is that
environmental damage caused by the quarrying must be remedied on completion of the
quarrying. In this case, an obligation exists independently by the company’s future
conduct in relation to damage already caused at the end of the reporting period because
the company cannot avoid having to pay for remedial action. By contrast, no obligation
exits in relation to expected further damage from continued quarrying because the
company could decide not to quarry in the future.

Example 2:
Company Y operates aircraft that need periodic overhauls if they are to continue in
operation. No obligation exists in relation to future overhauls because the company
could decided to sell or scrap the aircraft rather than overhaul them.

Legal obligations Constructive obligations

Definition: Definition:
An obligation that derives from: An obligation that derives from an
 A contract (through explicit or implicit entity’s actions where:
terms).  by an established pattern of past
 Legislation; or practice, published policies or a
 Other operation of law. sufficiently specific current
statement, the entity has indicated to
Example: other parties that it will accept certain
A legal obligation would be a warranty responsibilities; and
provided at the time of sale to undertake  as a result, the entity has created a
necessary repairs for a specified period of valid expectation on the part of those
time. other parties that it will discharge
those responsibilities.

Example:
A retail store operates a policy of giving
refunds to customers that goes beyond
the company’s legal obligations. The
policy is long established and widely
known. It is likely that this policy creates
a constructive obligation, as a significant
breach of contract of the policy would
damage the company’s reputation
considerably.

 If the above criteria are fulfilled then the enterprise need to make a provision for the
future liability.

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Example: (Reliable estimate)

An oil company has constructed an oil rig costing RM50 million to explore and extract oil for
5 years. It is a legal requirement that at the end of the operation, the entity has to clean up
the area and rectify any damage done to the seabed by the extraction of oil.
As the oil rig has been constructed, it might have damaged the seabed. Therefore, there is
a present legal obligation due to the past event (the past event being the construction of the
oil rig). The company has to estimate the present value of the clean-up cost that will be
incurred due to the construction of the oil rig and damage to the seabed due to extraction. If
60% of the damage is due to the construction of the oil rig, the present obligation is for 60%.
The damage due to extraction of oil is not yet an obligation.
Assume that the present value of the total clean-up amounts to RM4 million then RM2.4
million is to be provided for on completing the construction. The RM2.4 million is added to
the cost of the oil rig. The other costs are accrued as the extraction takes place.

Assume the company uses a discount rate of 8%.

Dr. Cr.
RM RM
1 Jan X1
Oil rig 52,400,000
50,000,000
Payables / cash
2,400,000
Provision for clean-up
31 Jan X1
Depreciation (RM52.4 million / 5 years) 10,480000
Accumulated depreciaiton 10,480,000
Finance cost (RM2.4 million x 8%) 192,000
Provision for clean-up 192,000
Clean-up cost ((RM4m-RM2.4m) x 1.08)/5 years 345,600
Provision for clean-up 345,600

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7. CONTINGENT
 Contingencies are events the outcome of which is determined by other events the
outcome of which are uncertain.

CONTINGENT
Contingent Liability Contingent Asset
DEFINITION a. A possible obligation that A possible asset that arises from
arises from past events and past events and whose
whose existence will be existence will be confirmed only
confirmed only on the on the occurrence or non-
occurrence or non-occurrence occurrence of one or more
of one or more uncertain future uncertain future events not
events not wholly within the wholly within the control of the
control of the enterprise; or enterprise
b. A present obligation that arises
from past events but is not Example:
recognized because: In November X3, a poultry
i. it is not probable that an farmer had to destroy all his
outflow of resources poultry due to a government
embodying economic benefits order to contain the spread of
will be required to settle the the avian flu. On 15 December
obligation, or X3, the government made a
ii. the amount of the obligation press statement stating that it
cannot be measured with would pay compensation to all
sufficient reliability the poultry farmers.
On 10 July X4, the farmer
received a letter specifying the
amount he would receive. Can
the farmer recognise an asset in
X3?
The farmer has to be virtually
certain of the receipt. A press
statement is not evidence of a
virtually certain situation.
Therefore, it can recognise the
asset in X4 on receipt of the
document confirming the
compensation.
RECOGNITION
CERTAIN /  Considered as LIABILITY  Recognised as an asset and
VIRTUALLY  Recognised as PROVISION income
CERTAIN
Journal Entries: Journal Entries:
Dr SOPL Dr Asset
Cr Provision Cr SOPL
Chance > 50%  Disclose in the Notes to
PROBABLE Account
30% <Chance <  NOT A LIABILITY IGNORE
50%  Disclose in the NOTES to
POSSIBLE account
Chance < 30% IGNORE IGNORE
REMOTE NO DISCLOSURE

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SUMMARY OF ACCOUNTING TREATMENT

Degree of Degree of Contingent liability Contingent asset

probability probability
Virtually certain Probability above Provide provision Recognise
(provision) 95%
Probable Probability above Provide provision Disclose by note
50% and up to 95%
Possible Probability 5% to Disclose by notes No disclosure
50%
Remote Probability below No disclosure No disclosure
5% (ignore)

8. MEASUREMENT

a) Best estimate
 The amount recognised as a provision shall be the best estimate of the expenditure
required to settle the present obligation at the end of the reporting period.
(MFRS137.36)
 The best estimate of the expenditure required to settle the present obligation is that
amount that entity would rationally:
o Pay to settle the obligations at the reporting date, or
o Transfer it to a third party at that time.
 The estimates of the outcome and the amount are determined by judgement of the
management, based on past experience of similar transactions and at times even
from reports from independent experts.

Example:

An entity sells goods with a warranty under which customers are covered for the cost
of repairs of any manufacturing defects that become apparent within the first six
months after purchase. If minor defects were detected in all products sold, repair
costs of 1 million would result. If major defects were detected in all products sold,
repair costs of 4 million would result. The entity’s past experience and future
expectations indicate that, for the coming year, 75 per cent of the goods sold will
have no defects, 20 per cent of the goods sold will have minor defects and 5 per cent
of the goods sold will have major defects. In accordance with paragraph 24, an entity
assesses the probability of an outflow for the warranty obligations as a whole.

The expected value of the cost of repairs is:

(75% of nil) + (20% of 1m) + (5% of 4m) = 400,000

b) Assess risks and uncertainties

 The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
(MFRS137.42)

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  Assessment of risks and uncertainties should be made by an entity in determining
the best estimate for the amount of the provision.
 Risk adjustment will increase the amount of liability.
 However, this does not justify the creation of excessive provisions or a deliberate
overstatement of liabilities.
 Risks and uncertainties surrounding events and circumstances should be considered
in arriving at the best estimate of a provision:
o If a group of items is being measured, it is the “expected value”.
o If a single obligation is being measured, it the “most likely outcome”.

c) Present value of the obligation

 Where the effect of the time value of money is material, the amount of a provision
shall be the present value of the expenditures expected to be required to settle the
obligation.(MFRS137.45)
 Because of the time value of money, provisions relating to cash outflows that arise
soon after the reporting period are more onerous than those where cash outflows of
the same amount arise later. Provisions are therefore discounted, where the effect is
material.
 The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s) current
market assessments of the time value of money and the risks specific to the liability.
The discount rate(s) shall not reflect risks for which future cash flow estimates have
been adjusted.
d) Future events
 Future events that may affect the amount required to settle an obligation shall be
reflected in the amount of a provision where there is sufficient objective evidence that
they will occur.
e) Gains or losses on disposal of assets
 Gains from the expected disposal of assets shall not be taken into account in
measuring a provision.

9. REIMBURSEMENT
 Where some or all of the expenditure required settling a provision is expected to be
reimbursed by another party, the reimbursement shall be recognised when, and only
when, it is virtually certain that reimbursement will be received if the entity settles the
obligation.
 The reimbursement shall be treated as a separate asset.
 The amount recognised for the reimbursement shall not exceed the amount of the
provision.
 In the statement of comprehensive income, the expense relating to a provision may
be presented net of the amount recognised for a reimbursement.

10. CHANGES IN PROVISONS

 Provisions shall be reviewed at the end of each reporting period and adjusted to
reflect the current best estimate. If it is no longer probable that an outflow of
resources embodying economic benefits will be required to settle the obligation, the
provision shall be reversed.
 Where discounting is used, the carrying amount of a provision increases in each
period to reflect the passage of time. This increase is recognised as borrowing cost.

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11. USE OF PROVISONS
 A provision shall be used only for expenditures for which the provision was originally
recognised.
 Only expenditures that relate to the original provision are set against it.
 Setting expenditures against a provision that was originally recognised for another
purpose would conceal the impact of two different events.

PROVISIONS – SPECIFIC APPLICATIONS

Future Operating Onerous Contracts Restructuring

Losses
A contract in which the Programme that is planned
unavoidable costs of and controlled by
meeting the obligations management, and
under the contract exceed materially changes either:
the economic benefits a. the scope of a business
expected to be received undertaken by an
under it enterprise;
b. the manner in which
that business is
conducted

Should NOT RECOGNISE PROVISION SHOULD BE Disposal of an operation-

as PROVISION RECOGNISED NO PROVISION IS
-recognise any impairment RECOGNISED because
losses before the provision there is no obligation to
recognize the disposal until
the enterprise is committed

Internal Restructuring
PROVISION SHOULD
ONLY BE RECOGNISED if
a constructive obligation
exists.

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12. DISCLOSURE

 MFRS137 requires an entity to disclose for each class of provision, the following
item:
o The carrying amount at the beginning and end of the period and any
movements:

Notes to the accounts

RM
Balance at beginning xxx
Additional/increases in provisions xxx
Amounts used (xxx)
Amounts released unused (xxx)
Finance cost (if discounted + change in P/L) xxx
Balance at end xxx
Comparative figure is not required.

 A brief description if the nature of the obligation and the expected timing of any
resulting outflows of economic benefits;
 an indication of the uncertainties about the amount or timing of those outflows.
Where necessary to provide adequate information, an entity shall disclose the major
assumptions made concerning future events, as addressed in paragraph 48; and
 the amount of any expected reimbursement, stating the amount of any asset that has
been recognised for that expected reimbursement.
 For each class of contingent liability, contingent liability that is not remote, a brief
description of the nature of contingent liability and where practicable, the estimate of
the financial effect, indication of uncertainties and possibilities of reimbursement.
 For a contingent asset that is probable, the entity is to dislose a brief description of
the nature and where practicable, the estimate of the financial effect.
 In extremely rare cases, if disclosure of some or all of the above information would
be seriously prejudicial, do not disclose them. In this case, an entity should state the
general nature of the provision the fact and the reason why the disclosure have not
have been made.

13. MALAYSIAN PRIVATE ENTITIES REPORTING STANDARD (MPER)

 The MPERS is based on the IASB’s International Financial Reporting Standard for
Small and Medium-sized Entities (IFRS for SMEs) issued in July 2009 except for the
amendments made in Section 1 Private Entities, Section 9 Consolidated and
Separate Financial Statements, Section 29 Income Tax and Section 34 Specialised
Activities.
 MPER for provision covers under Section 21 Provisions and Contingencies.

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ILLUSTRATION 1:

EXAMPLES OF PROVISIONS

CIRCUMTANCE RECOGNISE AS PROVISION

Restructuring by sale Only when the entity is committed to a sale, i.e. there is a binding sale
of an operation agreement
Restructuring by Only when a detailed form plan is in place and the entity has started to
closure or implement the plan or announced its main features to those affected. A
reorganization Board decision is insufficient.

Warranty When an obligating event occurs (sale of product with a warranty and
probable warranty claims will be made).
Land contamination A provision is recognised as contamination occurs for any legal
obligations of clean up, or for constructive obligations if the company's
published policy is to clean up even if there is no legal requirement to do
so (past event is the contamination and public expectation created by
the company's policy).
Customer refunds Recognise a provision if the entity's established policy is to give refunds
(past event is the sale of the product together with the customer's
expectation, at time of purchase, that a refund would be available).
Offshore oil rig must Recognise a provision for removal costs arising from the construction of
be removed and sea the the oil rig as it is constructed, and add to the cost of the asset.
bed restored Obligations arising from the production of oil are recognised as the
production occurs.

Abandoned leasehold, A provision is recognised for the unavoidable lease payments

four years to run, no
re-letting possible
CPA firm must staff No provision is recognised (there is no obligation to provide the training,
training for recent recognise a liability if and when the retraining occurs).
changes in tax law
Major overhaul or No provision is recognised (no obligation).
repairs
Onerous (loss- Recognise a provision.
making) contract

Future operating No provision is recognised (no liability).

losses

ILLUSTRATION 2:

Given below are situations that are independent of each other. For all situations, the financial
year end is 31 December 20x6 and the financial statements are expected to be approved by
the Board of Directors on 31 March 20x7.

For each situation, state the accounting treatment, the reasons and the amount involved if
applicable.

a) In December 20x6, Marakon Bhd was sued for damages arising from an accident that
the company's vehicle was involved in. As at 31 December 20x6, the company's lawyers
advised that it is probable the company would lose the case and would have to pay
damages amounting to RM200,000. However, the vehicle is insured and it is virtually
certain that the company could recover RM150,000 from the insurance company.

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 Answer: (Example of reimbursement)

In this case, the company should record the following adjusting entries:

Dr. SOPL – loss arising from accident RM200,000

Cr. SOFP – Provision from accident loss RM200,000

Dr.SOFP – Amount receivable from insurance RM150,000

Cr. SOPL – gain from insurance RM150,000

SOPL - extract
Other income: 150,000
Gain from insurance

Expenses: 200,000
Loss arising from accident

SOFP - extract
Current assets: 150,000
Amount receivable from insurance

Current liabilities: 200,000

Provision from accident loss

In SOPL, the net of RM50,000 will be charged as other losses. In SOFP, the provision
account will be presented as current liability item and the receivable account as current
asset item.

b) CC Bhd gives warranties at the time of sale to purchasers of its product to repair or
replace any defects within three (3) years from the date of sale. Based on past
experience, it is probable that there will be some claims under the warranties.

Answer:
A provision should be recognised on the goods sold as there is a probable outflow of
resources under the warranties as a whole assuming all the criteria are met.

c) An employee of Chemcorp is currently suing the company for damages in respect of

serious injuries sustained on 1 July 20x6 as a result of a breach of safety regulations.
The company’s lawyer indicates the following likely outcomes:

75% probability of a damage claim of RM4 million; and

25% probability of RM10 million.

The legal fee is estimated at RM550,000.

Answer:

A provision should be recognised as there is a present legal obligation due to the

past event. RM4 million has to be recognised as a provision as it is probable to be
incurred by the company whereas RM10 million is contingent liability and disclose to
the notes of the accounts. The legal fee is recognised as an expense in SOPL.

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Adjusting entries:
Dr. SOPL – loss arising from litigation RM4,000,000
SOFP – legal fee RM550,000
Cr. SOFP – Provision from litigation RM4,000,000
Bank RM550,000

SOPL - extract
Expenses:
Loss arising from litigation 4,000,000
Legal fee 550,000

SOFP - extract

Current liabilities:
Provision from litigation 4,000,000

Notes to the accounts:

During the financial year, an employee sued the company for RM14 million damages
in respect of serious injuries sustained on 1 July 20x6 as a result of a breach of
safety regulations. The company has been advised by its solicitors that it is possible
that the company has to pay RM10 million damages claim.

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