PROVISIONS

Contingent assets and liabilities

MERIAM L. BOTICALAO
 OBJECTIVE
to understand the nature of a
provision.
to know the conditions for the
recognition of a provision.
to know the measurement of a
provision.
to know the requirements for the
recognition of contingent liability and
contingent asset.
 PROVISION
an existing liability of uncertain timing and or uncertain
amount (and/or unidentified payee).
definitely exists at the end of the reporting period.
a provision may be the equivalent of an estimated liability or
a loss contingency that is accrued because it is both
probable and measurable.
RECOGNITION
PAS 37, P. 14
-recognized as a liability in the FS
under the following conditions:

the 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 would be required to
settle the obligation.
the amount of the obligation can
be measured realiably.
 RECOGNITION
PRESENT OBLIGATION
may be legal or contructive.
LEGAL - Obligation arising from a
contract, legislation or other
operation of law (e.g. tax)
CONSTRUCTIVE - exists when the
entity from an established pattern of
practice or stated policy has created
a valid expectation that it will accept
certain responsibilities.
PAST EVENT
-past event that leads to a present
obligation is called an obligating event.
-the event must have already occurred
which gives rise to the legal or
constructive obligation.
event that creates present obligation
because the entity has no realistic
alternative but to settle the obligation
created by the event.
 PROBABLE OUTFLOW OF RELIABLE ESTIMATE
ECONOMIC BENEFITS
PAS 37, p. 25, provides that the
use of estimate is an essential
an outflow of resources is part of the prep. of financial
regarded as probable if the event statements and does not
is more likely than not to occur. undermine liabilities.
using range of possible outcomes,
the probability that the event will the entity usually woud be able
occur is greater than the probability to make an estimate of the
that it will not. obligation that is sufficiently
this means more than 50% likely reliable.
or substantially more
Additional info:
probable: 51% or more
when no reliable estimate can be
possible: 50% or less made, no liability is recognized
remote: 10% or less
MEASUREMENT AMOUNT
- the amount recognized as a provision
should be at best estimate of the expenditure
required to settle the pesent obligation at the
end of the reporting period.

Approaches:
1. Midpoint of the range
(highest + lowest)/2
2.Expected value
sum of all possible amount
multiply to their corresponding
probability.
 SAMPLE PROBLEMS
01 ILLUSTRATION - MIDPOINT OF
THE RANGE
On December 31, 2023, the entity provided an
estimated liability ranging from 120,000 to
140,000.

Formula: (highest + lowest)/2

= (140,000 + 120,000)/2
= 260,000/2
= 130,000
 SAMPLE PROBLEMS
02 ILLUSTRATION - EXPECTED
VALUE
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 6 months after purchase.

If minor defects are detected in all products sold, repair costs would be about P1.000.000.

If major defects are detected in all products sold, repair costs of P5,000,000 would result.

The entity's past experience and future expectations indicate that 75% of the goods sold will have no defects, 20% will have
minor defects and 5% will have major defects.

The expected value or cost of repairs is measured by weighting all possible outcomes by their associated probabilities.

75% sales NONE

20% sales (20% x 1,000,000) 200,000
5% sales (5% x 5,000,000) 250,000
Total expected value or cost of repairs 450,000
 OTHER
MEASUREMENT the following items are taken into
consideration in recognizing and measuring a
CONSIDERATION provision:
1. Risks and uncertainties
2. Present value of obligation
3. Future events
4. Expected disposal of assets
5. Reimbursements
6. Changes in provision
7. Use of provision
8. Future operating losses
9. onerous contracts

RISK AND UNCERTAINTIES
-shall be taken into account in
reaching the best estimate of
a provision.
-describes variability of
outcomes.
-risk adjustment may increase
the amount at which a liability
is presumed.
FUTURE EVENTS
PRESENT VALUE OF
OBLIGATION -that affect the amount required to settle an
obligation shall be reflected in the amount of
-the amount of provision shall be
provision where there is sufficient evidence
the present value of the expenditure
that they will occur (e.g. new legislation and
expected to settle the obligation.
changes in technology)
-discount rate should be a pretax
rate that reflects the current
market assessment of the time value
of money and the risk specific to
the liability.
-discount rate should NOT reflect
the risk for which cash flow
estimates have already been adjusted.
 CHANGES IN PROVISION USE OF PROVISION ONEROUS CONTRACTS
-provision shall be reviewed at every -a contract in which the unavoidable costs
-A provision shall be used only for of meeting the obligation under the
end of the reporting period and
expenditures for which the contract exceed the economic benefits
adjusted to reflect the current best
provisions was originally recognized. expected to received under it.
estimate.
If it so happened, it possibly
constitutes to financial reporting UNAVOIDABLE COSTS
-provision shall be reversed if it is no -PAS37,P.68, mandates that this costs
fraud
longer probable that an outflow of under a contract represent the least net
economic benefits would be required to cost of exiting from the contact.
FOR EXAMPLE:
settle the obligation.
a provision for plant LEAST COST OF EXITING FROM THE
dismantlement cannot be used to CONTRACT
-where discounting is used, the
absorb environmental pollution claims -the lower amount between the cost of
carrying amount of the provision fulfilling thr contract and the
or warranty payments.
increases each period to reflect the compensation or penalty arising from
passage of time. failure to fulfill the contract.
 EXAMPLES OF
EXAMPLES:
PROVISION
warranty
environmental
contamination
decommissioning or
abandonment cost
court case
guarantee
CONTINGENT
ASSETS AND
LIABILITIES
CONTINGENT LIABILITIES
PAS 37, P. 10, defines a contingent liability in two ways:
- a possible obligation that arises from past event
and whose existence will be confirmed only by the occurrence
or nonoccurrence of one or more uncertain future events
not wholly within the control of the entity.
- a present obligation that arises from past event
but is not recognized because it is not probable that an
outflow of economic benifits resources will be required to
settle the obligation or the amount of the obligation
cannot be measured reliably.
 CONTINGENT
LIABILITY
contingent liability is a present
obligation.
CONTINGENT
LIABILITY vs.
present obligation is either probable
or measurable but not both to be
considered a contingent liability

PROVISION
PROVISION
if the present obligation is probable
and the amount can be measured
reliably, the obligation is not a
contingent liability but a provision.
 -shall not be recognized in the
financial statements but should be
disclosed only. TREATMENT OF
The required disclosures are:
a. a brief description of nature of
contingent liability.
CONTINGENT
b. estimate of its financial effects.
c. an indication of uncertainties that LIABILITY
exist.
d. possibility of any reimbursement.

If a contingent liability is remote,

no disclosure is necessary
CONTINGENT - a possible asset that arises from past event and whose existence will be
confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the entity.

ASSET TREATMENT
-shall not be recognized because this may result to recognition of income
that may never be realized.

However, when the realization of income is virtually certain, the related asset
is no longer contingent asset.

a contingent asset is only disclosed when it is probable.

If a contingent asset is only possible or remote, no disclosure is
required.
 LIABILITIES

DISCLOSED ONLY RECOGNIZED

IGNORED

0% 10% 50% probable 95% reasonably 100%

remote possible certain

DISCLOSED ONLY RECOGNIZED

ASSETS IGNORED

info:
probable: 51% or more
possible: 50% or less
remote: 10% or less
 Provision
Illustrative Problem 1:
On November 5, 2026, Pepper Company truck was in an accident with an auto driven
by Graciel. Pepper received notice on January 15, 2027 of a lawsuit for P 700,000 damages = 200,000 + 450,000
for personal injuries suffered by Graciel. 2
Tegan Price, Pepper's legal counsel, believed it is probable that Graciel will be awarded = 325,000
an estimated amount in the range between P 200,000 and P 450,000, and no amount is a
better estimate of potential liability than any other amount because each point in the
range is as likely as any other. The 2026 financial statements were issued on March 1, 2027.

Required: What amount of loss should be accrued on December 31, 2026?

 Provision
Illustrative Problem 2:
=0
During 2026, Pepper Company is the defendant in a patent infringement lawsuit.
Annalise Keating, Pepper's lawyer, believes that there is a 70% chance that the court will
dismiss the case and the entity will incur no outflow of economic benefits. This is with the probable-- 50%
help of Bonie and Frank, Annalisse's employees.
However, if the court rules in favor of the claimant, Annalise believes that there is a
20% chance that the entity will be required to pay damages of P 200,000 and an 80%
chance that the entity will be required to pay damages of P 100,000. Other outcomes are
unlikely.
The court is expected to rule in late 2028. There is no indication that the claimant will
settle out of court.
Required: What is the measurement of the provision for lawsuit?
Illustrative Problem 3:
During 2026, Pepper Company is the defendant in a patent infringement lawsuit. Annalise Loss:
Keating, Pepper's lawyer, believes that there is a 30% chance that the court will dismiss the case 200 000 x 20% = 40 000
and the entity will incur no outflow of economic benefits. 100 000 x 80%= 80 000
However, if the court rules in favor of the claimant, Annalise believes that there is a 20% chance
that the entity will be required to pay damages of P 200,000 and an 80% chance that the entity
will be required to pay damages of P 100,000. Other outcomes are unlikely.
70% loss x 120 000= 84 000
The court is expected to rule in late 2028. There is no indication that the claimant will settle out 30% Win = 0
of court.
A 7% risk adjustment factor to the probability-weighted expected cash flows is considered PROVISION
appropriate to reflect the uncertainties in the cash flow estimates. =84 000 x 1.07 x . 907
An appropriate discount rate is 5% per year. The present value of 1 at 5% for 2 periods is 0.907.
=81 521
Required: What is the measurement of the provision for lawsuit?
 RESTRUCTURING
DEFINITION
-PAS 37, P.1O, defines restructuring as a
program planned and controlled by management
and materially changes either the scope of a
business of an entity or the manner in which
the business is conducted.
EVENTS THAT MAY QUALIFY AS RESTRUCTURING:
a. sale or a termination of a line of business.
b. closure of business loc., relocation of bus.
act., or relocation of headquarter from one
country to another.
c. change in management structure
d. fundamental reorganization of an entity
that has a material and significant impact on its
operation.
PROVISION
-recognition of provision for restructuring is
required because a constructive obligation may
arise from the decision to restructure.
a constructive obligation arises for
restructuring when two conditions are
present:
1. the entity has a detailed formal plan
for the restructuring.
2. The entity has created a valid
expectation in the minds of those affected that
the entity will carry out the restructuring by
starting to implement the plan and announcing
the main features to those affected by it.
AMOUNT
-a restructuring provision shall only include direct
expenditures arising from the restructuring.
for example:
salaries and benefits of employees to be incurred
after operation cease.
-Excludes:
a. cost of retaining or relocating continuing
staff.
b. marketing or advertising program to promote
the new company image.
c. investment in new system and distribution
network.
Such expenditures are disallowed as restructuring
provisions because the above expenditures relates to
the future conduct of the business entity, and thus are
not liabilities relating to the restructuring program.
 DECOMISSIONING LIABILITY
DEFINITION ACCOUNTING ENTRIES SETTLEMENT
Purpose of expenditure (e.g. equipment) xxx Accumulated depreciation
-is an obligation to dismantle, cash xxx Equipment
remove and restore an item of Decommissioning liability xxx
REALIZATION:
property, plant and equipment as
Depreciation Decommissioning liability
required by law or contract. It is Accumulated Depreciation Cash
also called as asset retirement
obligation. Interest expense
Decommissioning liability
Decommissioning liability
Loss on settlement of decommissioning
liability
COST OF PPE CHANGES IN ESTIMATE Cash
1. Purchase price If increase: Equipment
Decommissioning liability Decommissioning liability
2. Directly attributable cost Cash
3. Estimated cost of dismantling If decrease: Decommissioning liability Gain on settlement of decommissioning liability
Equipment
Illustrative Problem: AMORTIZATION TABLE
On January 1, 2022, an entity engaged in extracting natural gas and oil constructed a drilling
INTEREST EXPENSE PRESENT
DATE
platform for P25,000,000 and is required by Philippine law to remove and dismantle the platform (12%) VALUE

at the end of its useful life of 10 years.

1 610 000
The straight line method is used in depreciating the drilling platform. The entity had estimated
that such decommissioning will cost P5,000,000. Based on a 12% discount rate, the present value
12/31/2022 193 200 1 803 200
of 1 for 10 years is 0.322.
Thus, the present value of the decommissioning liability is P5,000,000 times 0.322 or P1,610,000.
12/31/2023 216 384 2 019 584
The decommissioning liability is initially recognized at present value and included in the cost of
the related asset. Decommissioning liability: Depreciation Expense: 12/31/2024 242 350.08 2 261 934.08
Principal-Salvage value
Estimates 5 000 000 Useful life
x Present value 0.322 = 26 610 000
1 610 000 10
= 2 661 000
 decommissioning liability
Journal entries for 2022 and 2023
2022
settlement of decommissioning liability
Jan. 1 Drilling platform 26 610 000
Cash 25 000 000
Decommissioning liability 1 610 000
On December 31, 2031, after 10 years, the entity contracted with another
entity to dismantle and remove the drilling platform for P5,500,000.
Dec. 31 Depreciation 2 661 000 Decommissioning liability - January 1, 2022 1,610,000 The settlement of the decommissioning liability is normally recorded as
Interest expense for 2022 193,200
Accumulated depreciation payment of liability.
Carrying amount - December 31, 2022 1,803,200
(26,610,000/10 years) 2,661,000 Decommissioning liability 5 000 000
Interest expense for 2023 (12% x 1,803,200) 216,384 Loss on settlement of decommissioning liability 500 000
31 Interest expense 193 200
Decommissioning liability 193 200 Cash 5 500 000
(12% x 1,610,000) On January 1, 2022, the decommissioning liability is P1,610,000. This
2023 amount plus 12% interest compounded annually will build up to
P5,000,000 after 10 years on December 31, 2031.
Dec. 31 Depreciation 2,661,000
Thus, the decommissioning liability is debited at P5,000,000. The
Accumulated depreciation 2,661,000
carrying amount of the drilling platform is derecognized on December
31 Interest expense 216 384 31, 2031.
Decommissioning liability 216,384
Accumulated depreciation 26,610,000
Drilling platform 26,610,000
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