IAS 37 Provisions,

Contingent Liabilities and

Contingent Assets
Question Bank
QUESTION 37-A (17 MARKS)

IT LIMITED is a wholesaler in computer hard drives. All sales contracts grants customers a one-month
guarantee on the purchased hard drives. Esque Limited supplies IT Limited with their trading inventories.

All returned hard drives that are still under guarantee are sent to Esque Limited for repairs. Esque Limited
invoices IT Limited for all the repair costs. Esque Limited investigates the reason for the repairs and pays
IT Limited for all repair work that had to be done due to Esque Limited’s lack of quality control. Repairs to
hard drives due to negligence on the part of the customer is not reimbursed. IT Limited trusts the integrity
of Esque Limited as they enjoy a five-year business relationship.

The following information of IT Limited for the reporting period ended 28 February 20.5, is presented to
you:
Additional
information R

Cost of sold trade inventories still under guarantee at 1 March 20.4 1. 690 000
Cost of sold trade inventories still under guarantee at
28 February 20.5 1. 740 000
Invoices received from Esque Limited for repairs on trade
inventories under guarantee (net of reimbursements) 3. 59 300
Reimbursements against invoices from Esque Limited charged i.r.o.
repairs to hard drives under guarantee 2. 6 500

Additional information:

1. Experience in the past showed that 50% of all sold trade inventories are returned to IT Limited in
terms of the guarantee. The repair costs of these returned hard drives is estimated at 20% of the
original cost of sales.

2. The trend during the past four years showed that 10% of the returned hard drives that are still under
guarantee and that were sent to Esque Limited were faulty due to defective quality control by Esque
Limited. The realisation of any reimbursement estimates is not virtually certain.

3. Payments made to Esque Limited during the reporting period ended 28 February 20.5 amounted to
R49 300. On 1 March 20.4 a zero balance was owed to Esque Limited for repair work to hard drives
under guarantee.

REQUIRED:

1. Discuss, with reference to IAS 37 “Provisions, contingent liabilities and contingent assets”, whether
a provision shall be recognised for trade inventories still under guarantee at the end of the reporting
period in the financial statements of IT Limited for the reporting period ended 28 February 20.5 (8)

2. Disclose all relevant information relating to the provision in the notes of IT Limited for the reporting
period ended 28 February 20.5, in compliance with IFRS. (Assume that a provision for guarantees
may be recognised). (9)
___
(17)
Please note: - Comparative amounts are not required.
- Assume all amounts are material.
- Round off all calculated amounts to the nearest R1.
QUESTION 37-A (SUGGESTED SOLUTION)

1. A provision is a liability of uncertain timing or amount.

A provision shall be recognised if:

• an entity has a legal or constructive obligation;

• due to events in the past;
• it is probable that an outflow of resources embodying economic resources will result to settle
the obligation; and
• the amount can be estimated reliable.

Present legal obligation:

The sales contracts of the hard drives grants a one-month guarantee through its implicit terms. The
sales of the previous month is currently still under guarantee.

Due to events in the past:

The sales of the hard drives, that are still under guarantee at the end of the reporting period, already
occurred during the last month.

It is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation:

Evidence in the past proved that 50% of all sold trade inventories are returned to IT Limited under
guarantee (the event is therefore more likely than unlikely). All returned hard drives that are still
under guarantee, are sent to Esque Limited for repairs. Esque Limited invoices IT Limited for all
repair work costs. IT Limited is compelled to pay the invoices from Esque Limited when the hard
drives are repaired (service rendered).

The amount can be estimated reliably:

Evidence in the past showed a 50% possible outcome for trade inventories under guarantee.

Therefore, an estimate of the obligation that is sufficiently probable may be used to recognise the
provision, namely 20% of the original cost of sales’ value.

As guarantees are only valid for one month, the time value of money may be regarded as immaterial.

Conclusion:

All recognition criteria are complied with. The only remaining uncertainty is the timing (at which date
in the following month?) and amount.

A provision may be recognised.

Although some of the costs are reimbursed, the full amount is still recognised as a provision. The
reimbursement is treated as a separate asset.
 -3-

QUESTION 37-A (SUGGESTED SOLUTION - CONTINUED)

2. IT LIMITED
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.5

3. Profit before tax:

Profit before tax is shown after the following items had been taken into account:

R
Income:

Reversals of unused guaranteed provision 3 200 3

Reimbursements of guarantee provisions received 6 500

Expenses:

Guarantee provision 74 000 4

10. Guarantee provision:

Carrying amount at beginning of period 69 000 1

Amounts used during the period (repair costs) (65 800) 2
Unused amounts reversed during the period (3 200) 3
Provision for the period 74 000 4
Carrying amount at end of period 74 000

One-month guarantees are granted on all sales contracts of hard drives. It is estimated that repair
costs on hard drives sold during February 20.5 will be incurred in March 20.5.

The estimated amount that will be reimbursed on the above mentioned provision is R7 4005. (Refer
to note 11).

11. Contingent asset:

Returned hard drives under guarantee are returned to the supplier. The supplier investigates the
reason for the repair and reimburses IT Limited for all repair work resulting from a lack of quality
control by the supplier. The trend for the past four years showed that 10% of returned hard drives
still under guarantee and returned to the supplier were faulty due to faulty quality control by the
supplier.

The best estimate of amounts that must be reimbursed on the provision for the reporting period
ended 28 February 20.5 is R7 4005. (Refer to note 10).
QUESTION 37-A (SUGGESTED SOLUTION - CONTINUED)

CALCULATIONS:

(1) Provision 1 March 20.4:

R690 000 x 50% x 20% = R69 000

(2) Provision used during the year ended 28 February 20.5:

R59 300 + R6 500 = R65 800

(3) Unused amounts transferred to the income statement for the year ended 28 February 20.5:
R69 0001 – R65 8002 = R3 200

(4) Provision 28 February 20.5:

R740 000 x 50% x 20% = R74 000

(5) Contingent asset 28 February 20.5:

R74 0004 x 10% = R7 400

The following is only supplied for completeness sake:

Guarantee provision (SoFP) Guarantee provision (P/L)

Creditors 65 800 Balance 69 000 Provision
(SoFP) 74 000 P/L 74 000
Reversed (P/L) 3 200 Provision (P/L) 74 000
Balance 74 000
143 00 143 000
0
Balance 74 000

Guarantee provision reversed (P/L)

P/L Provision
3 200 (SoFP) 3 200

Creditor: Esque Limited (SoFP) Reimbursements received (P/L)

Asset (Reim- Guarantee
bursed) 6 500 provisions 65 800 P/L 6 500 Creditors 6 500
Bank 49 300
Balance 10 000
65 800 65 800
Balance 10 000

Bank (SoFP)
Creditors 49 300

Abbreviations:

P/L - Profit or loss

SoFP - Statement of financial position
QUESTION 37-B (25 MARKS)

Lia Limited is a motor manufacturer. During the past reporting period in general in general it fared well,
except for one model that was introduced to the market six months before the end of the reporting period.

A few weeks after the first vehicle was sold, it became clear that there were serious problems with the
steering mechanism of the model. The company found that one part is defective. The following cases
must now be dealt with:

Case 1

One person who drove the new model was involved in a car accident in which he sustained serious back
injuries. The person instituted a claim against the company in terms of which the company is summoned
for his medical costs, as well as for an amount of R2 000 000 for personal discomfort and loss of revenue.
At the end of the reporting period the person was still undergoing treatment for the injuries thus sustained.
(10)

Case 2

Due to the bad press reports in the media, Lia Limited issued a press report in which all vehicles were
recalled for the free replacement of the defective motor part. Lia Limited did a detailed costing per vehicle.
They are however uncertain whether all vehicles will be returned for the repairs. (11)

Case 3

Lia Limited instituted a claim against the Korean manufacturer of the part. The latter undertook to bear
the full cost of the repair work, as well as all administrative costs that had to be incurred due to the defect.
(4)

REQUIRED:

Discuss how each of the cases should be treated for accounting purposes (identify and recognise if
appropriate) and disclosed in terms of IAS 37 Provisions, contingent liabilities and contingent assets.
Supply all the relevant definitions in your discussion.
____
(25)
QUESTION 37-B (SUGGESTED SOLUTION)

CASE 1 – Claim against the company

The obligating event is the sale of the vehicle with a defective part ✓

• The claim is a legal obligation as it results from the operation of law ✓

• In this case the claim is a contingent liability ✓

• and will not be recognised. ✓

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 recognised 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 (par .11) ✓

The following should be disclosed:

- an indication of the uncertainties relating to the amount and timing of any outflow (it is
uncertain how much should be paid as the person is still being treated – wait for completion
of legal process) ✓

- the probability of any reimbursement ✓

An estimate of the financial effect cannot currently be made (par .87) ✓

_________
(14→ 10)
QUESTION 37-B (SUGGESTED SOLUTION - CONTINUED)

CASE 2 –Replacement of defective part

The company has a constructive obligation due to the current published statement in the
national press that the repairs will be undertaken, and ✓

a valid expectation is therefore created on the part of customers that this responsibility will be
undertaken (par .11). (If definition of constructive obligation is supplied - 2 marks) ✓

The company must create a provision for the total costs, ✓

A provision is a liability of uncertain timing or amount. (Do not know whether all vehicles will be
returned for repairs) (par .11). ✓

The obligating event was the sale of the vehicles with a defective part. ✓

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 (par .11) ✓

The following should be disclosed:

- a reconciliation of the movement in the provision for the period (in this case the creation,
amounts used during the year and the carrying amount at the end of the reporting period
(par .85) ✓

- a brief description of the nature of the obligation ✓

- the estimated timing of the resulting outflow of economic benefits ✓

- an indication of the uncertainties on the amount and timing of the outflows ✓

- the amount of the expected reimbursement (see case 3), stating the amount of the
expected reimbursement that was recognised as an asset (par .86). ✓
_________
(12 → 11)
CASE 3 -

- The amount that will be received from the Korean supplier is a reimbursement. ✓

- The amount should be recognised when it is virtually certain that reimbursement will be
received (have undertaking by Korean company). ✓

- The reimbursement should be recognised as a separate asset. ✓

- The amount of the reimbursement may not be exceed the amount of the provision (par ✓
.54)

- In the statement of comprehensive income (p/l) the income and expense may be offset
(par .55). ✓

- It is not a contingent asset, as the inflow of economic benefits is virtually certain. ✓

_______
(6 → 4)
____
(25)
QUESTION 37-C (10 MARKS)

Grootegeluk Mining Company is an entity that mines coal in the Carolina district in Mpumalanga. The
mining is done using the open cast mining method and the company mines mostly thermal and coking
coal products. Although there is a great demand for coal world-wide, the industry is inundated with
environmental problems.

MATTER 1:

As the mining rights were only awarded on a temporary basis, the rights were only obtained for a period
of 10 years. The company obtained its mining rights on 1 April 2010. In terms of the mining contract
Grootegeluk Mining Company needs to rehabilitate the environment on expiry of its contract. The
rehabilitation is estimated to cost R10 million in ten years’ time. The relevant discount rate was 9% in
2011 and 8% in 2012. The company has adopted a formal policy to provide for the rehabilitation costs in
compliance with IAS 37 Provisions, contingent liabilities and contingent assets.

MATTER 2:

During the reporting period ended 31 March 2012 the company accidentally dumped coal slurry in the
nearby swamp. Coal slurry is a solid and liquid waste byproduct of coal mining. The discharge coated
rocks and plants and increased the amount of iron and suspended solids in the swamps for several weeks.
The swamp houses unique birds and frog species. A group of environmentalists, calling themselves
“Saving Mpumalanga” have instituted a civil claim against the company to repair the damage to the
environment due to the dumping. After consultation with its legal advisors, the directors of Grootegeluk
Mining Company are of the opinion that the success of the lawsuit is possible and that an obligation exists.
However, it is not possible to estimate the potential loss at the reporting date.

REQUIRED:

a) Discuss the recognition of the matters arising from the information above for the reporting
periods ended 31 March 2011 and 2012 with reference only to IAS 37 Provisions,
contingent liabilities and contingent assets. (10)

(10)
 - 10 -
QUESTION 37-C (SUGGESTED SOLUTION)

a) Identification and recognition of elements

MATTER 1: 

Rehabilitation of environment on expiry of mining rights 

The entity has a present obligation in terms of the mining rights contract that it obtained. 
The past obligating event is the obtaining of the mining rights which requires the rehabilitation 
of contamination and damage to the environment due to the open cast mining process.
The entity has a legal obligation as the rehabilitation is a condition of the mining rights 
contract.
The outflow of resources embodying economic benefits is probable. 
A provision should be recognised (for the present value of the rehabilitation costs in ten 
years’ time).
(5)

MATTER 2:
Civil claim due to dumped coal slurry

The claim is a contingent liability as it is a present obligation (the directors have concurred 
with this) that arises from past events (dumping of coal slurry) 
but is not recognised because: 
- it is not probable that an outflow of resources embodying economic benefits will be 
required to settle the obligation (not relevant) or
- The amount of the obligation cannot be measured with sufficient reliability (the 
directors have determined that the potential loss cannot be estimated at the reporting
date)
The directors shall disclose the contingent liability in the financial statements at 
31 March 2012.
(5)
QUESTION 37-D (20 MARKS)

Bored Motors Ltd (hereafter Bored Motors) is a motor manufacturer and dealer that has been operating in
South Africa for decades. Lately the company has received very bad press as a result of events described
below:

In December 2015 a Cougar 1.6L Eco model caught fire in the Western Cape and the driver who did not
escape in time was killed. The family immediately contacted Bored Motors, but they denied responsibility
for the incident. Bored Motors were of the opinion, based on advice from their technical team, that it was
an isolated incident. The family, not being satisfied with the response started a social media campaign
about the incident. Bored Motors did not even get legal advice at that stage, due to their view on the issue.

During 2016 more Cougars caught fire and started to attract a lot of media attention. When the CEO was
confronted he said that the fires were due to overheating caused by the engine coolant and not electrical
faults in the vehicle. The company did however realise that it was involved in a potentially damaging
situation and contacted their lawyers for legal advice. The lawyers were of the opinion that it was probable
that the company would be found negligent and held responsible for the repair or replacement of the
vehicles if a civil action was lodged against the company. The following probabilities relating to the
replacement or repair of the vehicles would apply:

Probability Amount
R
20% 2 000 000
30% 4 000 000
40% 10 000 000
10% 20 000 000

(The estimates above do not relate to the company’s estimate for normal repairs under guarantee which
may be ignored for the purpose of this question).

The family of the first person that died in December 2015 instituted a civil claim against Bored Motors
during August 2016 for personal loss of a loved one for an amount of R17 000 000. The legal advisors
of the company were of the opinion that the claim would probably succeed, but were not able to estimate
the amount of damages that would have to be paid reliably.

The lawyers’ fees for the advice above amounted to R3 800 000 and was paid on 28 February 2017.

By January 2017, 46 Cougar vehicles were reported to have caught fire. Meanwhile the SA Consumer
Commission started investigating the issue and came to the conclusion that Bored Motors is liable for any
losses due to the burning of Cougar vehicles. On 16 March 2017 Bored motors officially recalled all Cougar
vehicles manufactured between December 2012 and February 2014 for repairs. It is estimated that
repairs and replacements will cost the company R21 200 000

REQUIRED:

1.1 Discuss the recognition and disclosure of the matters arising from the information above in
the financial records of Bored Motors for the reporting periods ended 31 December 2015
and 2016 with reference only to IAS 37 Provisions, contingent liabilities and contingent (15)
assets.

1.2 Prepare the relevant journal entries to account for the implications of the events relating to
the defective vehicles during the current reporting period which will end on 31 December (5)
2017.

Brief journal narratives are required.

(20)
QUESTION 37-D (SUGGESTED SOLUTION)

1.1 Discussion of recognition and disclosure in 2015 and 2016

2015: 

The civil claim against the company is a contingent liability 
i.e. 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 (Rest of the definition not relevant).
A contingent liability is not recognised. 
As the possibility of an outflow of economic resources is regarded as remote, no disclosure

will be done.
(4)
2016:
The obligation to repair/replace the vehicles is a provision:
A provision is a liability of uncertain timing or amount. 
The entity has a present legal  The legal advisors are of the opinion that the 
obligation; company would be found guilty if a civil action
was lodged. The vehicles were sold with a
guarantee.
As a result of a past event;  The selling of a vehicle with a guarantee 
and the vehicles subsequently catching fire.
It is probable that an outflow  The legal advisors are of the opinion that it is 
embodying economic benefits will be probable that the company will be found
required to settle the obligation; and guilty
A reliable estimate can be made of the  The legal can estimate the amount: 
amount of the obligation.
A provision of R7,6 million ((2 000 000 x ,2) +(4 000 000 x ,3) + (10 000 000 x ,4) + (20 000 000 x .1)) Amt
should be recognised. Prin
(15 →13)
In addition:
Obligation for legal services rendered:
A liability (payable) should be recognised for R3,8 million. 
Obligation in respect of civil claim by the family for personal loss of a loved one: 
A contingent liability should be disclosed. 
(15)
1.2 Journals for 2017
2017 R R
Feb 28 Legal costs payable (FP)  dr 3 800 000
Bank (FP) cr 3 800 000 
Payment of legal advisors.
2017
16 Mar Repair and replacement costs (P/L)  dr 13 600 000 
Provision for repairs and replacement (FP)  cr 13 600 000
Recognition of increased obligation i.r.o. of Cougar
models (21 200 000 – 7 600 000)
(5)
(20)
QUESTION 37-E (20 MARKS)

WV Limited is a motor manufacturer located in Durban. During September of the current reporting period,
WV introduced a new car model called the “WV MAG”. The new model received tremendous interest from
the market as it was considered to be an ideal starter motor, retailing at R150 000 each with leather seats
and luxurious trimmings. The company sold a total of 10 000 vehicles during the current reporting period.

A few weeks after the first vehicle was sold, it was discovered that there were serious problems with the
ABS braking system installed in the WV MAG. The company’s technical investigation team found that one
part used in the braking system is faulty. The motor industry is highly regulated and there are laws
governing the safety of vehicles. The following two cases related to the faulty braking system have been
reported to WV Limited before the reporting date and must now be dealt with:

Case 1

A man from KZN was on his way to Johannesburg to deliver a new WV MAG to his child, when he was
involved in a car accident on the N3 highway. He sustained serious knee injuries. The man’s lawyer
submitted a claim against the company in terms of which the company is summoned to pay his medical
costs of R50 000, a full refund of the purchase price of the vehicle, as well as an amount of R6 000 000
for personal discomfort and loss of revenue.

The company admitted that the ABS braking system could have been faulty, however it may not have been
the main cause of the accident. By the end of the reporting period the court case had not been concluded
and the company’s lawyers believed that the claim may possibly succeed, but it was not highly probable,
nor highly unlikely at the reporting date. (9)

Case 2

During the reporting period WV received a lot of bad publicity on social media in connection with the WV
MAG model. The spokesperson of WV issued a press statement in which all vehicles were recalled for the
free replacement of the faulty part of the ABS breaking system. WV Limited did a detailed costing review
and estimated that R2 000 will be incurred per vehicle. They are not certain whether all vehicles will be
returned for the repairs. Based on history and industry norms it is estimated that approximately 8 000 of
the vehicles that were sold during the year would be returned for repairs. (11)
(11)

REQUIRED:

Discuss how each of the cases should be treated for accounting purposes (identify and recognise or
disclose if appropriate) in terms of IAS 37 Provisions, contingent liabilities and contingent assets.

Supply all the relevant definitions and supporting calculations as part of your discussion.
____
(20)
QUESTION 37-E (SUGGESTED SOLUTION)

CASE 1 – Claim against the company

The issue is whether a provision should be recognised for the claim against the company. ✓

A provision is a liability of uncertain timing or amount. (Marked just once for question) ✓

The obligating event is the sale of the vehicle with a defective part ✓

The claim is a legal obligation as it results from the operation of law ✓

A claim was instituted against the company for medical costs, refund of the purchase price ✓
and personal discomfort and loss of revenue.

It could however be argued that it is only a possible obligation, as the company’s lawyers
believed that the claim may possibly succeed, but it was not highly probable, nor highly ✓
unlikely at the reporting date.

The claim therefore meets the definition of a contingent liability: ✓

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,

The matter will only be concluded by the court ruling. ✓

The company cannot control the outcome of the court case ✓

Conclusion: A contingent liability should be disclosed ✓

_________
(11 limited to 9)
QUESTION 37-E (SUGGESTED SOLUTION - CONTINUED)

CASE 2 –Replacement of defective part

Issue – Should a provision be recognised for repair claims? ✓

A provision is a liability of uncertain timing or amount. (Award only once) ✓

Liability is a:
a) Present obligation arising from a past obligating event:
- The company has a present constructive obligation due to the current published ✓
press release in which it committed to undertake all necessary repairs, and ✓
- a valid expectation has therefore been created on the part of customers that this
responsibility will be undertaken and ✓
- WV has no realistic alternative to settling that obligation
✓
(If definition of obligating event or constructive obligation is supplied – 1 additional mark
each)

b) The settlement of which will result in an outflow of economic benefits ✓

- The repair costs to be incurred will result in an outflow of cash resources of R2,000
per vehicle repaired for WV Limited. ✓

The obligating event was the sale of the vehicles with a defective part. ✓

(A student could also argue that the obligating event was the public announcement, as selling
a vehicle with a faulty product is only an obligating event if the repair was guaranteed at the
time of sale.)

The definition of provision is met however for a provision to be recognised, it must meet ✓
the recognition criteria:

It is probable that the company will have to incur the repair costs as they have committed ✓
to do so by making a public announcement and inviting al WC MAG owners to return the ✓
vehicles for repairs.

The amount of the provision should be reliably measurable and provided for at ✓
management’s best estimate of the amount to be incurred
- A reliable estimate can be made as follows: ✓
R2,000 x 8,000 vehicles = 16 000 000

Conclusion: The company should recognise a provision for R16 million in respect of the ✓C
expected repairs of the faulty breaking system in the new year

_________
(15 → 11)
(2 bonus marks possible)
QUESTION 37-F (20 MARKS)

Proudly SA (Pty) Ltd (hereafter Proudly SA) is an on-line retailer that only sells products that are
manufactured in South-Africa. One of the products sold by Proudly SA is a very effective vacuum pump,
based on a relatively simple design that is manufactured by We-can (Pty) Ltd (hereafter We-can). We-
can is situated in the Free state and its workers come from the surrounding informal areas. All vacuum
pumps sold via Proudly SA’s on-line platform are supplied by We-can with a three-month guarantee
against faulty workmanship.

All vacuum pumps that are returned to Proudly SA within the three-month guarantee period are
subsequently sent to We-can for repairs or replacement. We-can invoices Proudly SA for all the repair
costs. We-can investigates the reason for repairs and if it is due to We-can’s negligence reimburses
Proudly SA for the repair work necessitated by We-can’s lack of quality control. Repairs to vacuum
pumps due to negligence on the part of the customer is not reimbursed. Proudly SA trusts the integrity
of We-can as they enjoy a long business relationship.

The following information of Proudly SA for the reporting period ended 30 June 2018, is presented to
you:
Additional
information R

Cost of sold trade inventories still under guarantee at 1 July 2017 1. 380 000
Cost of sold trade inventories still under guarantee at 30 June 2018 1. 490 000
Invoices received from We-can for repairs on trade inventories
under guarantee (net of reimbursements) 3. 16 400
Reimbursements against invoices from We-can charged i.r.o.
repairs to vacuum pumps under guarantee 2. 2 200

Additional information:

1. Experience in the past showed that 20% of all sold trade inventories are returned to Proudly SA in
terms of the guarantee. The repair costs of these returned vacuum pumps is estimated at 30% of
the original cost of sales.

2. The trend during the past five years showed that 15% of the returned vacuum pumps that are still
under guarantee and that were sent to We-can were faulty due to defective quality control by We-
can. The realisation of any reimbursement estimates by We-can to Proudly SA is not virtually
certain.

3. Payments made to We-can during the reporting period ended 30 June 2018 amounted to R18 600.
On 1 July 2017 a zero balance was owed to We-can for repair work to vacuum pumps under
guarantee.

REQUIRED:

1. Discuss, with reference to IAS 37 Provisions, contingent liabilities and contingent assets,
why it is correct to recognise a provision for vacuum pumps still under guarantee at the end of the
reporting period in the financial statements of Proudly SA for the reporting period ended 30 June
2018 (10)

2. Does Proudly SA have a contingent asset related to the guarantee provided by We-can in terms of
IAS 37 and if so, how should it be treated for accounting purposes? (4)

3. Prepare all the journals related to the guarantee provision for the reporting period ended 30 June
2018 . (12)
Please note: - Journal narrations are required. (20)
QUESTION 37-F (SUGGESTED SOLUTION)

1. A provision is a liability of uncertain timing or amount. ✓

A provision shall be recognised if:

• an entity has a legal or constructive obligation;

• due to events in the past;
• it is probable that an outflow of resources embodying economic resources will result to settle the
obligation; and
• the amount can be estimated reliable. ✓

Present legal obligation:

The sales contracts of the vacuum pumps grant a three-month guarantee through its implicit terms. The
vacuum pumps sold during the previous three months are still under guarantee at the reporting date. ✓

Due to events in the past:

The sales of the vacuum pumps, that are still under guarantee at the reporting date, had occurred during the
last three months of the reporting period. ✓

It is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation:

Evidence in the past proved that 20% of all sold trade inventories are returned to Proudly SA under
guarantee (the event is therefore more likely than unlikely). All returned vacuum pumps that are still under
guarantee, are sent to We-can for repairs. We-can invoices Proudly SA for all repair work costs. Proudly SA
is compelled to pay the invoices from We-can when the vacuum pumps are repaired (service rendered). ✓

The amount can be estimated reliably:

Evidence in the past showed a 20% possible outcome for returns of vacuum pumps under guarantee.
Therefore, an estimate of the obligation that is sufficiently probable may be used to recognise the provision,
namely 30% of the original cost of sales’ value. (OR Cost of sales x 20% x 30%) ✓

As guarantees are only valid for three months, the time value of money may be regarded as immaterial. ✓
(Bonus mark)
Conclusion:

All recognition criteria are complied with. A provision may be recognised. ✓

(8)

2. Yes, Proudly SA does have a contingent asset related to the Provision for Guarantee claims. ✓

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. ✓

The reimbursement owing to Proudly SA is contingent on the supplier selling faulty products to the entity. ✓

The reimbursement is disclosed in a note. ✓

The best estimate of the amount to be reimbursed (R4 410) is supplied in the note. ✓
(5 limited to 4)
QUESTION 37-F (SUGGESTED SOLUTION - CONTINUED)

3. Journal entries related to guarantee provision.

2019 Guarantee provision (SFP) ✓ dr 18 600 ✓Amt

31 Dec We-can payable (SFP) cr 18 600
Provision used during the year (16 400 + 2 200)

Guarantee provision (SFP) ✓ dr 4 200 ✓Amt

Guarantee provision (P/L) cr 4 200
Reversal of unused provision (R22 800 – R18 600)

We-can payable (SFP) dr 2 200 ✓

Reimbursement received (P/L) cr 2 200 ✓
Recognition of reimbursement

Guarantee provision (P/L) dr 27 900 ✓

Guarantee provision (SFP) cr 27 900 ✓
Recognition of provision at end of year
(R490 000 x 20% x 30%)

(8)
(20)