IAS 37 – PROVISION, CONTIGENT LIABILITY AND CONTIGENT ASSET

I. PROVISION
- A liabilityi of uncertain timing or uncertain amount.
-It 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 the settlement.

A. When to recognize a provision?

(a) Has a present obligation; (b) It is probable; (c) Can be measured reliably

*A present obligation arises if obligating eventii has happened.

 A Legal obligation is an obligation that  A Constructive obligation arises if past
derives from: practice, published policy, or public
(a) a contract (through its explicit or announcement creates a valid
implicit terms); expectation on the part of a third party.
(b) legislation; or
(c) other operation of law.

B. Measurement of provision
The amount recognized should be the best estimate of the expenditure required to settle the present
obligation at the balance sheet date, that is, the amount that an entity would rationally pay to settle the
obligation at the balance sheet date or to transfer it to a third party. This means:
- Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit)
are measured at the most likely amount.
- Provisions for large populations of events (warranties, customer refunds) are measured at a
probability-weighted expected value.
- Both measurements are at discounted present value using a pre-tax discount rate that reflects
the current market assessments of the time value of money and the risks specific to the liability.

C. Application of Rules to specific situations

Future operating losses
- A reasonable expectation that carrying on trading/operations in future would result in loss.
Treatment These do not meet the definition of a liability because there is no present obligation;
therefore, no provision is recognized.
An expectation of a future operating losses is an indication that certain assets of the
operation may have been impaired.
Onerous contract
- When the unavoidable costs of meeting the contractual obligations – i.e. the lower of the costs of
fulfilling the contract and the costs of terminating it – outweigh the economic benefits.
Treatment The present obligation under the contract shall be recognized and measured as a
provision.
Unavoidable costs represents the least net cost of exiting from the contract.
Restructuring
- A sale or termination of a line of business, closure of business locations, changes in management
structure or a fundamental re-organisation of the company.
 Treatment A provision for restructuring costs is recognized only when the general recognition
criteria are met
A constructive obligation only arises when a detailed formal plan is in place and it has
begun or been announced to those affected by it. A board decision is not enough.
Restructuring provisions should include only direct expenditures caused by the
restructuring, not costs that associated with the ongoing activities of the entity.
II.CONTINGENT LIABILITY III.CONTINGENT ASSET

- Financial obligations that might or might not
arise in the future, dependent on the
outcome of a particular event.
- Shall not be recognized
- Shall be disclosed only
Ex: a company warranty and a lawsuit against
the company. Both represent possible losses to
the company, yet both depend on some
uncertain future event.
- possible asset that arises from past events
- inflow is probable
Ex: when you are suing somebody else and expect
winning the court case with some compensation
from other party, in such a case result of court
proceedings is out of your control and this possible
compensation would represent contingent asset.

Provision vs Contingent Liability

Provision is accounted for at present as a result of Contingent liability is recorded at present to

past event. account for a possible future outflow of funds.

Occurence

The occurrence of provision is certain. The occurrence of contingent liability is conditional.

Estimate

The amount of provision is largely not certain. A reasonable estimate can be made for the amount
of payment.

Inclusion in Statement of Financial Position

Recorded as a decrease in assets. Recorded as an increase in liabilities.

Inclusion in Income Statement

Increase or decrease of provision is recorded It is not recorded in the income statement.

THE DIFFRENCEC BETWWEEN PROVISION AND CONTINGENT LIABILITY

SUMMARY OF ACCOUNTING TREATMENT

DEGREE OF PROBABILITY OBLIGATION ASSET

Virtually certain (95%+) Recognize a Liability Recognize a Normal Asset

Probable (50%+) Recognize a Provision Disclose a Contingent Asset

Possible (5%-50%) Disclose a Contingent liability -Do nothing-

Remote (less than 5%) -Do nothing- -Do nothing-

i
Liability – a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits. If there is no past event then
there is no obligation and liability.
ii
Obligating Event – an event that creates legal or constructive obligation that results in an entity having no
realistic alternative to settling that obligation.

CASH AND CASH EQUIVALENTS

Things to remember about cash:

- It is one of the most liquid asset and the most prone to lose due to theft or mishandling
- Must be unrestricted and available for use
- Cash is money, used as currency and exchange
- There are two types of Cash:
 Cash on hand – simply put, it is Cash that you have on hand and not deposited in a bank
 Cash in Bank – it is cash that was deposited in the bank and can be withdrawn
- Cash funds are cash that will be used for a specified reason.
Cash fund for current asset =  ex. Petty, payroll, travel, interest, dividend & tax fund
Cash fund for NCA =  ex. Sinking, preference share, contingent fund (any long term
investment)

Things to remember about cash equivalents:

Cash Equivalents are money making instruments/short investments that are near its maturity date (3
months). It must be liquid and there would be no significant change (increase/decrease) to its value.

Ex. Three-month BSP Treasury bill,

three month time deposit
three month money market instrument
commercial paper

Petty Cash Fund

The
petty cash fund is utilized for everyday expenses, composed of bills & coins to pay for small expenses that does
not require checks.
Accounting procedures for Petty Cash

Bank Reconciliation

- Is a monthly prepared statement that balances books and bank Records

 Book Reconciling items
* Credit memos (+) are items that are recorded in the bank but have not yet been recorded in the books
ex. Note receivables collected by bank
proceeds of a bank loan
matured deposits transferred by the bank to depositors account

*Debit memos (-) are items recorded in the books but not yet shown in the depositor’s bank records
ex. Non-sufficient funds (NSF checks) – checks that aren’t accepted because of lack of funds
Defective checks – checks with errors (no signature, mutilated countersigned)
Bank Service charge (BSC) – bank charges for interest, collection and penalty

Bank Reconciling Items

* Deposit in Transit (+) are collections that have yet to be reflected in the bank statement but already is
recorded in the books of the depositor

* Outstanding checks (-) are checks that have already been recorded by the depositor but not yet reflected
in their bank statement.

Error – Can be seen in both Book and Bank, can either be added or deducted depending if it is overstated
or understated in the book// bank statement

Proof of Cash
Proof of Cash is a two date bank reconciliation which is used to find and fix the ending balance of the book
and bank statement. It balances the book and bank statement’s beginning, receipts, disbursements and
ending balance of the period.

Quick formula for DIT and OC

RECEIVABLES
  Represents any legitimate claim from other companies (money, goods, service)
 (in accounting) claims that are expected to be settled in cash
 From sales, performance of service, from money lent, etc.
 Evidenced by promissory note or time draft
 Trade Receivables: arising from normal course of business
 Non-trade Receivables: arising from other sources (e.g. accrued interest, advances to employees)
 In the Financial Statement: classified as current asset since expected to be collected within normal
operating cycle; otherwise: non-current
 Initial Recognition: initially recognized at the transaction price; only recognized when entity comes into
contract
Discounts
 Trade discounts: for converting catalog price to actual charge
 Cash discounts: for prompt payment; 1/5 , n/60 means 1% discount if paid within 15 days, payable
within 60 days
Interest Bearing Note
 For payment of interest for the time between date issued up to due date
 On issuance: present value is face value
 Subsequent present value is face value plus accrued interest based on interest rate
 Initially recognized when an entity becomes payee to the writer of the note
 Recognized at transaction price or fair value of the non-cash asset given up or fair value of note
received (discounted cash flow of future collections, based on implicit interest)
 Must not be due yet, otherwise it is reclassified as accounts payable and subsequently put into bad
debts expense (dishonored note)
 Illustration:
July 1: A issues a 60 – day, P500,000 10% note to B on merchandise acquired.
August 31: B collects due from A.
July 1:
Notes Receivable 500,000
Sales 500,000
August 31:
Cash 508,333.33
Notes Receivable 500,000
Interest Revenue 8,333.33
Non- Interest Bearing Note
 Makes no provisions for interest
 However, there is still interest accruing
 Note is written with the imputed interest on the face value for the term of the rate
 When exchanged for cash only, present value or amortized cost of note is equal to the cash proceeds
 When exchanged for non-cash assets, recorded at fair value of that asset
 When undeterminable, an imputed rate is used
  Amortized cost = present value of principal & interested discounted by the rate; either at a premium
or discount
Subsequent Measurement
 Subsequently measured at amortized cost
 Given: financial instrument is held for contractual cash flows and terms of the asset gives rise to
payment of principal and interest on specified dates
Impairment
 Uncollectible receivables
 Recognized in profit or loss
 Either through allowance method or direct right- off
 When previously written off but subsequently recovered/collected:
Accounts Receivable xxx
Bad debts recovered xxx

Cash xxx
Accounts receivable xxx
 IFRS 9 requires disclosure of expected credit losses from financial instruments
Receivable Financing
 to accelerate cash inflows by selling receivables or using them as collateral
 Secured borrowing: pledging, assignment, discounting of note with recourse
 Sale of receivables: discounting without recourse, factoring
 Pledging: use of receivables as collateral for a loan, general assignment
 Assignment of accounts receivable: receivables are identified and used as security for a loan; specific
assignment, borrower remits collections from receivables
 Discounting of notes receivable: a note’s maturity is advanced by a financing company through
endorsement of an entity, less discount (charge); sale of receivable, no total detachment from
obligations
 Discounting without recourse: total sale of receivable with derecognition since the entity is relieved of
further obligations; no liability is recorded by the seller
 Factoring: transfer of receivables without recourse, Factor Company assumes risk of collection; factor’s
holdback held for purchase returns and is returned when not consumed. Any excess in factor’s
holdback consumed by purchase returns = payable.

STOCKHOLDERS’ EQUITY
Equity refers to the assets of a business after paying off its liabilities, as such Stockholders’ Equity is the
residual interest found in a corporation or the stockholders’ share. It is one of the three elements of
Accounting, with the other two being Assets and Liabilities. It is a main component in the balance sheet that
makes up the Accounting Equation of Assets = Liabilities + Equity. (In the Balance Sheet, the Stockholders’
Equity is the difference between Assets and Liabilities)
Illustration 1:
May Corporation has the following information derived from its 2019 Balance Sheet:
Assets 1,570,000
Liabilities 900,000
What is the balance for Stockholders’ Equity?
Answer:
Equity = Assets – Liabilities
1,570,000 – 900,000 = P670,000
Stockholders’ Equity is used as a means to estimate how well a corporation is operating, to determine
whether or not it is within the range of bankruptcy or solvency. This takes into account its corporate capital and
income, among others. It can be found in two financial statements, namely the balance sheet and the
statement of stockholders’ equity.
The Stockholders’ Equity, in the Statement of Stockholders’ Equity, can be accounted for by its three
main components: Paid in Capital, Retained Earnings and Treasury Stock.
PAID IN CAPITAL
It is comprised of the overall contribution of the stockholders, wherein it includes Share Capital,
Subscribed Share Capital, and Share Premium of both Preferred and Ordinary stock.
Share Capital – represents the capital of the total authorized, issued and outstanding stock bought by the
stockholders.
Subscribed Share Capital – capital that is brought about by the individual subscriptions made by the
stockholders, which can be paid for in many forms (such as cash, land or property).
Share Premium – the excess of Paid in Capital added into its net amount.
RETAINED EARNINGS
It is the resulting profits or losses found within the course of business in a corporation. Profits earned is
added into the stockholder’s equity, meanwhile, losses incurred are deducted. This is the account wherein
dividends are drawn from.
Dividends serve as the distribution of profits of a company on a periodic basis. Which is dependent on
the accumulated earnings of a corporation.

TREASURY STOCK
It is the value that results from the shares reacquired by the corporation after its preceding issuance to
stockholders. They are different from that of issued and unissued stock, wherein both have voting rights,
treasury stock – as a result of its subsequent reacquisition by the corporation do not have those rights.
Treasury stock is a contra-equity account that is deducted from total paid in capital plus or minus retained
earnings in order to get the amount of stockholders’ equity.
Illustration 2:
June Corporation has the following information:
Share Capital P 1,000,000
Subscribed Share Capital 700,000
Share Premium 200,000
Retained Earnings 50,000
Treasury Stock 30,000
What is the Stockholders’ Equity balance?
Answer:

Add:

Share Capital P1,000,000

Subscribed Share Capital: 700,000

Additional Paid in Capital:

Share Premium 200,000

Total Paid in Capital 1,900,000

Retained Earnings 50,000

Less: Treasury Stock (30,000)

Stockholders’ Equity P1,920,000

Stockholders’ Equity is a key-component used in judging the capacity of a corporation to flourish. It also
describes the corporation best, by analyzing its strengths and weaknesses periodically found within the
changes – increase and decrease in equity accounts.