22 pas 37 - LIABILI * Objective, Scope and Definition ~ Q&A #1-5 © Recognition and Measurement ~ Q&A #6-23 © Disclosures - Q&A #24 «PERS for SMEs OBJECTIVE, SCOPE AND DEFINITION 1. What is the objective of the standard? The objective of PAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount. 2. What is the scope of this standard? PAS 37 shall be applied by all entities in accounting for provisions, contingent liabilities and contingent assets, except: a. Those resulting from executory contracts, except where the contract is onerous; and b. Those covered by another standard e.g. financial instruments (PFRS 9) 3. What is a provision? According to PAS 37, a provision is a liability of uncertain timing or amount. 4. What is an obligating event? As provided under PAS 37, and obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. 5. What is the difference between a legal obligation and a constructive obligation? Under PAS 37, a legal obligation is an obligation that derives from a contract, legislation or other operation of law. Whereas, constructive obligations is an obligation that derives from an entity’s actions where by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities, 424Chapter 22~PAS 37 Provisions, Contingent Liabilities and Assets RECOGNITION AND MEASUREMENT 6. Whats the difference between a contingent llability and provision? Under PAS 37, a contingent liability is a possible obligation that arises from past events and 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; or a present obligation that arises from past events but is not recognized because It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or the amount of the obligation cannot be measured with sufficient reliability, Whereas, a provision is 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, 7. When does an entity recognized a contingent lial ity? The entity will not recognize any contingent liability as it lacks the requirements for recognition of a liability under conceptual framework. However, PAS 37 paragraph 27 and ag provides that a contingent liability will be disclosed in the notes to financial statements, unless the possibility of an outflow of resources embodying economic benefits is remote. 8. When does an entity recognize a provision? When a contingent liability fulfils the recognition requirement of a liability, it becomes a provision. Therefore, a provision is only recognized when and only when the following conditions are met: a An entity has a present obligation (legal or constructive) as result of past event. b. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and c. Areliable estimate can be made of the amount of the obligation. 9. What is an obligating event? An obligating event is when a past event leads to a present obligation. For an event to be an obligating event, itis necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the case only: a. Where the settlement of the obligation can be enforced by law; or b. In the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation. 10. Cite an example of a constructive obligation that gives an obligating event. An example is when an environmental damage is caused where there may be no obligation to remedy the consequences, However, the causing of the damage will become an 425ch ‘ 'apter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets obligatiny . : . Ae when the entity publicly accepts responsibility for rectification. In this case, yy accepting such responsibility creates the constructive obligation. 11. ee can ee of resources or other event be considered as probable? ei 23 of PAS 37 provides that an outflow of resources or other event is regarded as prol able ifthe event ls more likely than not to occur; that is, the probability that the event will occur is greater than the probability that it will not. Therefore, if there is no probability (i.e. possible) that a present obligation exist, an entity discloses a contingent liability. However, if its likelihood to occur is remote neither recognition nor disclosure is made. 12. How to measure the reliable estimate of the obligation? Paragraph 36 of PAS 37 provides that the amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. That best estimate of the expenditure required to settle the preset obligation is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third part at that time. Whenever there are uncertainties surrounding the amount to be recognize as a provision are dealt with by various means according to the circumstances. Where the provision being involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities (otherwise known as expected value). Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range is used. 13, Should the risk and uncertainties surrounding the event be accounted? Paragraph 42 of PAS 37 provides that any risk and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision, Furthermore, a disclosure should be made on the uncertainties surrounding the amount of the expenditure. 14,15 there a need to take account the time value of money for the reliable estimate? ves, when such effect is material. Paragraph 45 provides that when the effect of the time value ef money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation. The discount rate to be used Shall be a pre-tax rate that reflects the current market assessments of the time value of money and the risks specific to the liability. 426Chapter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets 15. Should future events be reflected on the amount to be settled? Yes. Any future events that may affect the amount required to settle an obligation shai be reflected in the amount of a provision where there Is sufficient objective evidence that they will occur (Paragraph 48). 16. Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, when will such reimbursement be recognized? Under paragraph 53 of PAS 37, a reimbursement is recognized when, and only when, itis virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. It must be noted, that the amount to be recognize for the reimbursement shall not exceed the amount of the provision. Reimbursements are like contingent assets, it only becomes an asset and be recognized when such reimbursement becomes virtually certain. Furthermore, the expense relating to a provision may be presented net of the amount recognized for a reimbursement in the statement of comprehensive income. 17. What is contingent asset? A contingent asset is a possible asset that arises from past events and 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. 18, When does an entity recognize a contingent asset? The entity will not recognize a contingent asset for it lacks the recognition requirement of an asset. However, a contingent asset is disclosed, as required by paragraph 89 of PAS 37, where an inflow of economic benefit is probable. 19, Should the recognize provision be reviewed? Yes. Provision shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. When 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 20, Should a provision be recognized for future operating losses? No, since future operating losses do not meet the definition of a liability. An expectation of future operating losses is an indication that certain assets of the operation may be impaired and an entity tests these assets for impairment under PAS 36 Impairment of Assets. 427Ch 2 'apter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets 21. How does PAS 37 defines an onerous contract? Should an onerous contract be recognized as a provision? PAS 37 defines an onerous contract as a contract in which the unavoidable costs of meeting the obligation under the contract exceed the economic benefit expected to be received under it (Paragraph 68). Ifan entity has.a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision. 22. What is the general recognition criteria for restructuring? PAS 37 paragraph 72 provides that a constructive obligation to restructure arises only when an entity: a. Has a detailed formal plan for the restructuring identifying at least: i, The business or part of a business concerned; ii. The principal locations affected; iii, The location, function, and approximate number of employees who will be compensated for terminating their services; iv. The expenditures that will be undertaken; and v. When the plan will be implanted b. Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected byit. 23. Cite example of restructuring. a. Sale or termination of a line of business; b. The closure of business locations in a country or region or the relocation of business activities from one country or region or the relocation of business activities from one country or region to another; c. Changes in management structure, for example, eliminating a layer of management; and d. Fundamental reorganization that have a material effects on the nature and focus of the entity's operations. DISCLOSURE 24, What are the minimum required disclosures for PAS 37? a. For each class of provision, an entity shall disclose: i. the carrying amount at the beginning and end of the period; ii. additional provisions made in the period, including increases to existing provisions; ili, amounts used (ie incurred and charged against the provision) during the period; 428Chapter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets iv, unused amounts reversed during the period; and v. the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate. (Paragraph 85) TN: Comparative information is not required. b. An entity shall disclose the following for each class of provisior i. a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits; ii. 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 ili. the amount of any expected reimbursement, stating the amount of any asset that has been recognized for that expected reimbursement. PFRS for SMEs There is no significant differences between PFRS for SMEs and Full PFRS with respect to provision and contingencies. SUMMARY KEY POINTS © A provision is a liability of uncertain timing or amount. * An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. + The entity will not recognize any contingent liability as it lacks the requirements for recognition of a liability. However, it will be disclosed unless the possibility of an outflow of resources embodying economic benefits is remote. * A provision is recognized as liabilities because they are present obligations and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations. © Anoutflow of resources or other event is regarded as probable if the event is more likely than not to occur; that is, the probability that the event will occur is greater than the probability that it will not. * The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. * Time value of money for the reliable estimate is taken into account when the effect is moterial. © Areimbursement is recognized when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation * Accontingent asset is a possible asset that arises from past events and 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. 429a _ hapter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets + The entity will not recognize a contingent asset for it lacks the recognition requirement of an asset. However, it will be disclosed when an inflow of economic benefit Is probable. Exercise 22 - 1. Modified True or False.-Write your answers before the number. 1A pastevent that leads to a present obligation is called an obligating event. 2. Fora liability to qualify for recognition there must be not only a present obligation but also the possibility of an outflow of resources embodying economic benefits to settle that obligation. 3. An entity shall recognize a contingent liability. 4. Contingent assets are not recognized in financial statements since this may result in the recognition of income that may never be realized 5. The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. 6. In measuring the best estimate, where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range is used 7. The risks and uncertainties that inevitably surround many events and circumstances shall not be taken into account in reaching the best estimate of a provision. 8. Where the effect of the time value of money is material, the amount of a provision shall be the future value of the expenditures expected to be required to settle the obligation. 9. 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. 10. Gains from the expected disposal of assets shall not be taken into account in measuring a provision. 11. Provisions shall be recognized for future operating losses. 12. For a restructuring plan to be sufficient to give rise to a constructive obligation when communicated to those affected by it, its implementation needs to be planned to begin as soon as possible and to be completed in a timeframe that makes significant changes to the plan unlikely. 13. Comparative information is not required in disclosures for provisions. 14. Where an inflow of economic benefits is probable, an entity shall disclose a brief description of the nature of the contingent assets at the end of the reporting period, and, where practicable, an estimate of their financial effect. Exercise 22 - 2. Multiple Choice. Choose the best answer. 1. On March 22, year 1, Cole Corporation received notification of legal action against the firm. Cole's attorneys determine that it is probable the company will lose the suit, and the loss is estimated at 2,000,000, Cole’s accountants believe this amount is material and should be disclosed. Cole prepares Its financial statements in accordance with PFRS, How 430Chopter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets should the estimated loss be disclosed in Cole’s financial statements at December 31, year 2 a. Asa loss recorded in other comprehensive income. As a contingent liability reported in the balance sheet and a loss on the income statement ¢. As a provision for loss reported in the balance sheet and a loss on the income statement. d. Inthe footnotes to the financial statements as contingency. Roland Corp. signed an agreement with Linx, which requires that if Linx does not meet certain contractual obligations, Linx must forfeit land worth P40,000 to Roland, Roland's accountants believe that Linx will not meet its contractual obligations, and it is probable Roland will receive the land by the end of year 2. Roland uses PERS for reporting purposes. How should Roland report the land? 2. As investment property in the asset section of the balance sheet, b. Asa contingent asset in the current asset section of the balance sheet. c. Ina footnote disclosure if the economic benefits are probable. d. Asa contingent asset and other comprehensive income for the period. Under IFRS, which of the following accounts would not be considered a “provision”? a. Warranty liabilities b. Bad debts. c. Taxes payable. d. Note payable. Under IFRS, a contingency is described as a. Anestimated liability. b. An event which is not recognized because it is not probable that an outflow will be required, or the amount cannot be reasonably estimated. The same as itis described by US generally accepted accounting principles. d. A potentially large liability. Which of the following should be disclosed in the financial statements as a contingent liability? a. The entity has accepted liability prior to the year-end for unfair dismissal of an employee and is to pay damages. The entity has received a letter from a supplier complaining about an old unpaid invoice. ¢. The entity is involved in a legal case which it may possibly lose. d. The entity has not yet paid certain claims under product warranty. 431Chapter 22 ~ PAS 47 Provisions, Contingent Liabilities and Assets 6. Acontingent lability is a. Anestimated liability : b, An event which Is not recognized because It Is not probable that an outflow will be required or the amount cannot be reliably estimated c. A potential large liability d, A potential small liability 7. Contingent assets are usually recognized when a. Realized : b, Occurrence is reasonably possible and the amount can be reliably measured ©. Occurrence is probable and the amount can be reliably measured d. The amount can be reliably measured 8, Aprovision shall be recognized as liability when a. An entity has a present obligation as a result of a past event. b. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. c. The amount of the obligation can be measured reliably. d. All of these are required for the recognition of provision as liability. 9. Alegal obligation is an obligation that is derived from all of the following, except Legislation b. Acontract ¢. Other operation of law d, An established pattern of past practice 10. Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the range to be used is the a. Minimum b. Maximum c. Midpoint d. Sum of the minimum and maximum. 11. Disclosure usually is not required for a. Contingent gains that are probable and can be reliably measured b. Contingent losses that are reasonably possible and cannot be reliably measured ¢. Contingent losses that are probable and cannot be reliably measured d. Contingent losses that are remote and can be reliably measured 12, What condition is necessary to recognize an environmental liability ‘a. The entity has an existing legal obligation and the amount of the liabillty can be reliably estimated 43213. 14. 1s. 16. 17. Chapter 22 ~ PAS 37 Provisions, Contingent Liabilities and Assets b. The entity can be reliably estimate the amount of the liability c. The entity has an existing legal obligation d. Obligating event has occurred Which of the following is not considered when evaluating whether or not to record a liability for pending litigation? a. Time period in which the underlying cause of action occurred b. The type of litigation involved c. The probability of an unfavorable outcome d. The ability to make a reliable estimate of the loss An expropriation of asset which is imminent and for which the amount of loss can be reasonably estimated should be a. Accrued b. Disclosed c. Accrued and disclosed d. Ignored A contingent liability a. Has a most probable value of zero but may requires a payment if a given future event occurs Definitely exists as a liability but the amount or due date is indeterminate ls commonly associated with loss carryforward d. Isnot disclosed in the financial statements os . When the provision involves a large population of items, the estimate of the amount a. Reflects the weighting of all possible outcomes by the associated probabilities b. Is determined as the individual most likely outcome c. May be the individual most likely outcome adjusted for the effect of other possible outcomes Midpoint of the possible outcomes B. When the provision arises from a single obligation, the estimate of the amount a. Reflects the weighing of all possible outcomes by their associated probabilities b. Is determined as the individual most likely outcome c. Is the individual most likely outcome adjusted for the effect of other possible outcomes d. Midpoint of the possible outcomes. 43328. The unavoid: Oop ~ PAS 37 Provisions, Contingent Liabilities and Assets. idabls from th © costs under an onerous contract represent the “least net cost of exiting from the contract” which is equal to 3. Cost of fulfilling the contract Penalty arising from failure to fulfill the contract Lower of the cost of fulfilling the contract or penalty arising from failure to fulfill the contract Higher of the cost of fulfilling the contract or the penalty arising from failure to fulfill the contract. The likelihood that the future event will o will not occur can be expressed by a range of outcome. Which range means that the future event occurring is very slight? 3. Remote db. Reasonably possible Certain d. Remote p Which statement is incorrect concerning a contingent liability? 3. A contingent lisbility is not recognized in the financial statements. b, A contingent liability is disclosed only. c. if the contingent liability is remote, no disclosure is required. &. A contingent liability is both probable and measurable. Exercise 22 - 3. Identification. w is 2 liability of uncertain timing or amount. is an event thet creates 3 legal or constructive obligation that results in an entity having. no realistic alternative to settling that obligation. is 3 possible asset that arises from past events and 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. iss contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. is 3 program that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity or the manner in which that business is conducted. 2 possible obligation that arises from past events and 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. is an obligation that derives from an entity's actions where by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities and as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. 434