NAS 37 Provisions, Contingent

Liabilities and Contingent

Assets
CA Saugat Gautam
Liability

Present Obligation

As a result of past event

The settlement of which is expected to result in an outflow of

resources that embody economic benefits
Provision
Liability of uncertain:

• Amount, or
• Timing

A provision shall be recognized when: [ALL CONDITIONS]

• An entity has a present obligation (legal or constructive) as a result of a past

event;
• It is probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; and
• A reliable estimate can be made of the amount of the obligation.
Note 1: Present Obligation

• In rare cases, it is not clear whether there is a present

obligation. In these cases, a past event is deemed to give
rise to a present obligation if, taking account of all
available evidence, it is more likely than not that a
present obligation exists at the end of the reporting
period.
Note 2: Past event
Legal
Obligation
That derives from:
(a) contract (through its explicit
or implicit terms);
(b) legislation; or
(c) other operation of law.
Obligating
Event
Constructive
Obligation
That derives from
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.
Example
• A Ltd. has been contaminating
Bagmati river for several years. The
government introduced a law that
the ones who have polluted Bagmati
river will be heavily fined with Rs. 10
lakhs per instance. Is there a present
obligation for A Ltd.?

YES [LEGAL OBLIGATION]

PAST EVENT = Polluting Bagmati
Example
• A Ltd. has been contaminating
Bagmati river for several years.
There is no law for the clean-up of
pollution. However, the company
has widely published in annual
reports that it will clean the
contamination that it has caused. Is
there a present obligation for A Ltd.?

YES [CONSTRUCTIVE OBLIGATION]

PAST EVENT = Polluting Bagmati
Note 3: Probable outflow of resources embodying
economic benefits
• an outflow of resources or other event is regarded as probable if the event is more likely than not to occur,
ie the probability that the event will occur is greater than the probability that it will not.

Possible Probable

Remote ~ 0% ~ 100%- Virtually Certain

Example

• A Ltd. has been contaminating Bagmati river for several years. The
government issued a notice that the ones who have polluted Bagmati river
will be heavily fined with Rs. 10 lakhs per instance. Such notices have
frequently been issued but no action whatsoever has been taken by the
authority. Should provision be recognized ?

Present Obligation ? → YES [Legal Obligation]

Outflow probable ? → NO [indication of past experience]
Note 4: Reliable Estimate

Best Estimate Risk and Present Value Future events

Uncertainties
 Question
30 people died possibly as a result of food poisoning
from products sold by the entity in a conference. Legal
proceedings are started seeking damages from the
entity.
But it disputes liability. Upto the date of authorization
of the financial statements for the year to Ashad 31st
2072 for issue, the entity's lawyers advise that it is
probable that the entity will not be found liable.
However, when the entity prepares the financial
statements for the year to Ashad 32nd 2073, its lawyers
advise that owing to developments in the case, it is
probable that the entity will be found liable.
Should the entity create provision in FY 2071/072 and
FY 2072/073 ?
Answer

• No provision in 2071/72 since no present

obligation
• Recognise provision in 2072/73 since taking into
account of all evidence, it is more likely than not
that a present obligation (legal) exists.
Single outcome v/s Multiple Outcome

Single Multiple
Outcome Outcome
Use the expected
Use the most
outcome (statistical
likely outcome
calculation)
Example – Single Outcome
The company has estimated following clean-up costs:

Amount (Rs.) Probability

Most pessimistic 100 million 30%
Most likely 85 million 60%
Most Optimistic 70 million 10%
Example – Multiple Outcome
Sale with a warranty that manufacturing defects detected within 6 months of
purchase will be repaired.
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.
Past experience/Future expectation indicates that 75% of goods will have no
defect, 20% of the goods will have minor defects and 5% will have major defects.
What is the amount of warranty provision ?

Expected outcome = 75% x 0 + 20% x 1 million + 5% x 4 million

= Rs. 4,00,000
 Use of Provision
A provision shall be used only for expenditures for which the provision was originally
recognised.

Claim for patent infringement Court issued final decision Payment made by the company
(lawsuit) against the company
Rs. 5,00,000

Legal exp A/c (SoPL) – Dr. 5,00,000 Provision for legal suit A/c – Dr. 5,00,000
To Provision for legal suit 5,00,000 To Legal compensation payable 5,00,000

Legal Compensation payable A/c– Dr. 5,00,000

To Bank A/c 5,00,000
 Change in Provision
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.

Claim for patent infringement (lawsuit) With the developments in the

The company estimates Rs. 5,00,000 will hearing, the company believes
be required to settle. that Rs. 4,00,000 will only be
required to settle the obligation.

Legal exp A/c (SoPL) – Dr. 5,00,000 Provision for legal suit A/c – Dr. 1,00,000
To Provision for legal suit 5,00,000 To Reversal of provision expense (SoPL) 1,00,000
Future Operating Loss

Provisions shall not be recognised for future operating losses.

Future operating losses do not meet the definition of a liability and the general
recognition criteria set out for provisions.

Financial statements deal with the financial position of an entity at the end of its
reporting period and not its possible position in the future. Therefore, no provision is
recognized for costs that need to be incurred to operate in the future.
Onerous Contract [Cost > Benefit]
An onerous contract is a contract
in which the unavoidable costs of
meeting the obligations under
the contract exceed the
economic benefits expected to
be received under it.
If an entity has a contract that is
onerous, the present obligation
under the contract shall be
recognised and measured as a
provision.
The unavoidable costs under a
contract reflect the least net cost
of exiting from the contract,
which is the lower of:
the cost of fulfilling it and
any compensation or penalties
arising from failure to fulfil it.
Special Points for Provision

Provision is present obligation, not the future obligation. Because

the entity can avoid the future expenditure by its future course of
actions, no provision is recognized. [i.e., No provision if avoidable]

Where details of a proposed new law have yet to be finalised, an

obligation arises only when the legislation is virtually certain to be
enacted as drafted.
 Example
• An entity in the oil industry causes contamination but cleans up only when
required to do so under the laws of the particular country in which it operates.
One country in which it operates has had no legislation requiring cleaning up, and
the entity has been contaminating land in that country for several years. At 31
December 20X0 it is virtually certain that a draft law requiring a clean-up of land
already contaminated will be enacted shortly after the year-end.

Present obligation as a result of a past obligating event – The obligating event is the
contamination of the land because of the virtual certainty of legislation requiring cleaning up.

An outflow of resources embodying economic benefits in settlement – Probable.

Conclusion – A provision is recognised for the best estimate of the costs of the clean-up
Contingent Liabilities
• A contingent liability is:
(a) 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
(b) a present obligation that arises from past events but is not recognised
because:
(i) it is not probable that an outflow of resources embodying economic
benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient
reliability.
 Contingent Liability

Possible Obligation Present Obligation

Example: Bills Not probable

discounted outflow
OR
Cannot be
estimated reliably
 Recognition of Contingent Liability
• Shall not be recognized
• Shall be disclosed unless the possibility of outflow is remote.

DISCLOSE Possible Probable

DO Remote ~ 0% ~ 100%- Virtually Certain

NOTHING
 Question
30 people died possibly as a result of food poisoning
from products sold by the entity in a conference. Legal
proceedings are started seeking damages from the
entity.
But it disputes liability. Upto the date of authorization
of the financial statements for the year to Ashad 31st
2072 for issue, the entity's lawyers advise that it is
probable that the entity will not be found liable.
However, when the entity prepares the financial
statements for the year to Ashad 32nd 2073, its lawyers
advise that owing to developments in the case, it is
probable that the entity will be found liable.
Should the entity create provision in FY 2071/072 and
FY 2072/073 ?
Answer

• No provision in 2071/72 since no present obligation but

the entity should disclose a contingent liability.
• Recognise provision in 2072/73 since taking into account of
all evidence, it is more likely than not that a present
obligation (legal) exists.
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.
 Example
Entity A filed a case against its rival company B for patent (formula) infringement.

Case admitted Sample tested. The test results were out, Court gave the final
by A in the Test result will decide which showed that B had verdict in favor of
court the result of the case. indeed infringed the patent. entity A.
Entity A had already
tested sample which
showed that entity B
had indeed used the
formula

POSSIBLE PROBABLE VIRTUALLY CERTAIN

CERTAIN

DO DISCLOSE RECOGNISE THE

NOTHING ASSET
Recognition of Contingent Asset
• An entity shall not recognise a contingent asset.
• A contingent asset is disclosed, where an inflow of economic benefits
is probable.
• Contingent assets are not recognised in financial statements since this
may result in the recognition of income that may never be realised.
However, when the realisation of income is virtually certain, then the
related asset is not a contingent asset and its recognition is
appropriate.