PROVISIONS

CONTINGENT LIABILITIES
Provisions
● IAS 37 defines provision as liabilities of
entities the timing or amounts of which is
uncertain.
● It is recognized as financial liability
because it has both the criteria for
recognition which is probable outflow of
economic benefits and is measurable.
Examples of provision

● Warranties
● Environmental contamination
● Decommissioning or abandonment costs
● Court case
● Guarantee
Measurement of Provisions
● In IAS 37 states that the amount to be
recognized for the present obligation of
the entity is the reliable estimate at the
end of the accounting period required in
the settlement of the obligation.
 Other measurement considerations:

a. Risks and uncertainties

b. the use of pretax discount rate where the effect of time
value of money is significant
c. Future events such as law and technological changes
d. If there is a reimbursement that is virtually certain, the
amount of the reimbursement
recognized must not exceed the provision recognized.
 Reliable estimate:

a. the individual most likely outcome adjusted for

the effect of other possible outcomes – where the is
single obligation
b. the mid-point of the range - where there is range
of possible outcomes;
c. expected value – when a large population of
items exist
 Reliable estimate:

a. the individual most likely outcome adjusted for

the effect of other possible outcomes – where the is
single obligation
b. the mid-point of the range - where there is range
of possible outcomes;
c. expected value – when a large population of
items exist
 The cost to repair would be about 100,000 if minor defects are
ILLUSTRATION

detected in all products sold while major defects would cost

500,000. In the past experience of the company, it indicates
that 75% of the goods sold will have no defects, 20% will have
minor defects and 5% have major defects.

The expected value of cost of repairs:

75% sales none

20% sales (20%*100,000) 20,000
5% sales (5%*500,000) 25,000
Total 45,000
ILLUSTRATION
An explosion occurred at Global Company on November 15, 2019 which has
resulted to damage in property. By March 10, 2020, claims had been
asserted against Global company. The counsel concluded regarding the
pending lawsuit that an unfavorable outcome is probable and that Global
Company will be responsible for damages between 500,000 and 900,000 in
damages but 600,000 is a better estimate than any of the other amount.
The financial statements of the company was issued with the situation
remaining unchanged by the end of 2020.

Loss on lawsuit 600,000

Estimated liability for lawsuit 600,000
ILLUSTRATION

Assuming that in the previous illustration, the counsel states

that the estimated amount of damages is within the range
between 300,000 and 500,000 and the possible outcomes are
equally likely. The entry will be:
 

Loss on lawsuit 400,000

Estimated liability for lawsuit 400,000
Restructuring

● IAS 37 defines it 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 that business is conducted.”
Contingent liability
● The standard in IN18 defines contingent liability as
possible obligation arising from past event, the
existence of which will be confirmed by the
occurrence or non occurrence of one or more
uncertain future event or a present obligation but the
amount to settle cannot be measured reliably.

● It is not recognized in the financial statements

because the obligation is either probable or
measurable but not both. For a liability to be
recognized, it must be both probable and measurable.
Contingent liability
● A contingent liability requires disclosure only when the
range of the outcome is reasonably possible(more
than 50% likely). As per IAS 37.86, no disclosure is
necessary when the outcome of the future event that
will confirm the existence of the liability is only remote
(less than 50% likely).
Contingent asset
● It refers to a possible asset arising from past event,
the existence of which will be confirmed by the
occurrence or non occurrence of one or more
uncertain future event.

● A contingent asset is disclosed when probable and no

disclosure required when it is remotely possible. The
recognition is required only when the realization of
income is virtually certain.

● This one actually follows the conservatism principle in

dealing with future uncertain income.
Decommissioning liability
● It is an obligation to dismantle, remove and restore an
item of property and equipment as required by law.

● IAS 37 provides that the decommissioning cost is

recorded for the present value of the expected cash
outflow to decommission the site
ILLUSTRATION
Galendez company is engaged in the extraction of natural gas in the
Philippine deep.
On Jan.1, year 1, the entity constructed a drilling platform for
50,000,000 and is required by law to remove the platform at the end of
its useful life of 10 years.
The straight line method is used in depreciating the drilling platform.
The entity has estimated that such decommissioning will cost
10,000,000.
Based on a 12% discount rate, the present value of 1 for 10 years is
0.322.
 
Assume that on January 1, year 3, the amount expected to
decommission the site decreased by 2,000,000.
The present value of 1 at 12% for 8 years is 0.404.
ILLUSTRATION Jan. 1, year 1

Drilling Platform 53,220,000

Decom. liability 3,220,000
Cash 50,000,000
To recognize cost of asset and liability.

Dec. 31, year 1

Depreciation expense 5,322,000

Acc. Depreciation 5,322,000
To record annual depreciation.
 
Interest expense 386,400
Decommissioning liability 386,400
To record amortization of interest
ILLUSTRATION

Dec. 31, year 2

Depreciation expense 5,322,000

Acc. Depreciation 5,322,000
To record depreciation
 
Interest expense 432,768
Decommissioning liability 432,768
To record amortization.
 Jan. 1, year 3
ILLUSTRATION

Decommissioning liability 808,000

Drilling Platform 808,000
To record the change in decommissioning liability.
 
Dec. 31, year 3
Depreciation expense 5,221,000
Acc. Depreciation 5,221,000
To record depreciation.
 
Interest expense 387,740
Decommissioning liability 387,740
To record interest expense.