MFRS137 PROVISIONS,

CONTINGENT LIABILITIES
and CONTINGENT ASSETS

Reference page 743

 Lesson Outcome
At the end of this topic, you should be
able:
1. Define provisions.
2. Define contingent liability.
3. Distinguish between provision and contingent liability.
4. Explain the recognition of provision that give rise to
liability.
5. Explain the accounting treatment for provision and
contingent liability.
6. Define contingent assets
7. Explain the recognition of contingent liability and
contingent asset.
8. Explain the disclosure requirement.
 Conceptual Framework
 Definition-LIABILITIES
 Present obligation arising from past events, the
settlement of which is expected to result in an
outflow of resources embodying economic
benefits.
 Recognition criteria
1. Probable that an outflow of resources embodying
economic benefits will result from the settlement
of a present obligation.
2. The amount at which the settlement can be
measured realibly.

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Provisions pg 743
 MFRS 137 defines a provision as LIABILITY
OF UNCERTAIN TIMING or AMOUNT.
 The term provisions is used to cover
contingencies that are recognized as liabilities
in SOFP.
 The term contingent is used for liabilities and
assets that are not recognized as liabilities as it
is possible or remote because the y are fail the
recognition criteria.

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EXAMPLES OF OTHER LIABILITIES
 TRADE PAYABLES
 liabilities to pay for goods or services that have been
received or supplied and have been invoiced or
agreed with supplier

 ACCRUALS
 liabilities for goods or services that have been
received or supplied, but have not been paid,
invoiced or agreed with supplier

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 EXAMPLES OF PROVISIONS
 Provisions for warranty claims
 Liability arising from past sales, probable and
uncertain timing and amount
 Provisions for damages

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Contingency pg 742
Definition
 A condition or situation, the ultimate outcome of which,
gain or loss will be confirmed only on the occurrence or
non-occurrence of one or more uncertain future events.
 3 possibilities may be used as a guide:
1. Probable-the chance of the future event or events
occurring is high.
2. Possible- the chance of the future event or events
occurring is medium.
3. Remote-the chance of the future event or events
occurring is low(slight)
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Distinguishes between pg743
Provisions which are Contingent liabilities
recognised as liabilities which are NOT
assuming that a reliable recognised as liabilities
estimate can be made because:
because they are present 1. Possible obligations
obligations and it is which have yet to be
probable that an outflow confirmed OR
of resources embodying 2. Present obligations that
economic benefits will do not meet the
be required to settle the recognition criteria in
obligations. the Standard.
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 Recognition of a Provision pg 743
A provision shall be recognized when:
1. An entity has a PRESENT OBLIGATION (legal or
constructive) as a result of past event
2. It is PROBABLE that an OUTFLOW OF
RESOURCES (>50% chance) embodying
economic benefits will be required to settle the
obligation and
3. A RELIABLE estimate can be made of the AMOUNT
of the obligation.
Note: If these 3 criteria are not met, no provision shall
be recognized.
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 Present Obligation pg 744
 LEGAL OBLIGATION derives
from:
 A contract
 Legislation or
 Other operation of law.
 Legal obligations are enforceable at law in the
event of a non-performance by any of the
contracting parties.

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 Present Obligation
CONSTRUCTIVE OBLIGATION
derives from an entity’s action
where:
 By an established pattern of past practice,
published policies or 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.
 May not be enforceable at law.
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Recognition of provision
1. Present obligation arising from past event.
Past event has given rise to a present obligation.
Example 1
A direct selling company which has an established
policy of refunding purchases by dissatisfied customers
would have present obligations a result of past
obligating events.
Example 2
Automobile company that sells cars with 3-year
warranty for manufacturing defects, would have present
obligation as at the date of sale of each vehicle.
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Recognition of provision
2. Probable Outflow of Resources embodying
Economic Benefits.
The outflow of resources is regarded as probable if it is
more likely than not to occur that is the probability
that the outflow will occur is greater than the
probability that it will not.
50% change of occurrence based on management’s
best judgement.

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Recognition of provision
3. Reliable estimate of the obligation
The use of estimate is inevitable( certain to happen or
unavoidable).
Ability to determine a range of possible outcomes and
can therefore make an estimate of the obligation that is
sufficiently reliable to use in recognising a provision.

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 Measurement of a Provision pg 747
Amount recognized as a provision shall be the
 Best estimate of the expenditure required to settle
the present obligation at the end of reporting period.
Other requirements on the measurement are:
 Risks and uncertainties- the risks surrounding the
events and circumstances must be taken into account
 Present value-the effect of time value of money
determines the present value of future obligation
 The discount rate shall be a pre-tax rate that reflect
current market assessments of the time value of
money and the risks specific to the liability.
 Future events- the effect of future changes in technology
or legislations determines future obligation
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 LEGAL OBLIGATION-example 1
In November 2014, an employee of Ramesh Bhd
was injured while carrying on official duties.
He has filed a claim for damages from the
company to the amount of RM1 million.
Legal advice was sought by the company
60% chance – company will be held liable for
RM500,000
40% chance – company will be held liable for
RM1 million

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 LEGAL OBLIGATION
 OBLIGATING PAST EVENT????
 Employee filed claim for damages
 PRESENT OBLIGATION???
 Legal obligation – law exists
 PROBABLE OUTFLOW OF RESOURCES???
 More than 50% chance
 RELIABLE ESTIMATED AMOUNT???
 RM500,000

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 Provision-solution
  
1. Accounting treatment
Ramesh Bhd has to recognize a provision for damages
claimed by the employee. There is present
obligation(legal) due to a past event (employee has filed
for damages due to injury), that will result in probable
outflow of economic benefits (more than 50% chance)
and the amount can be measured reliably (RM500,000
determined by the lawyers).
2. Journal entries
Dr. SOPL – operating expense 500,000
Cr. Provision for damages 500,000

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CONSTRUCTIVE OBLIGATION-example 2
Aseh Bhd operates one of its factories in a foreign
country where no environmental law exists.
The company, however, claims to be a socially
and environmentally responsible corporate
citizen.
The factory operations have seriously hurt the
river’s ecosystem during the current year 2014.
The probable cleanup costs has been estimated at
RM1,500,000.

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 CONSTRUCTIVE OBLIGATION
 OBLIGATING PAST EVENT????
 Damage done to the river’s ecosystem
 PRESENT OBLIGATION???
 Constructive obligation – company’s
reputation)
 PROBABLE OUTFLOW OF RESOURCES???
 More than 50% chance
 RELIABLE ESTIMATED AMOUNT???
 RM1,500,000

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 Provision-solution
 
1. Accounting treatment
The company has NO LEGAL OBLIGATION to
rectify the environmental damage. However,
being socially and environmentally responsible, it
has a CONSTRUCTIVE OBLIGATION to
clean the river site. Thus, a provision of
RM1,500,000 will have to be made.
2. Journal entries
Dr. SOPL – operating expense 1,500,000
Cr. Provision for cleanup cost 1,500,000

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Application of the Recognition and
Measurement Principles
Future Operating Losses
Provision shall not be recognised for future operating
losses because do not meet the definition of a liability-
do not exist at the end of the reporting period.
Onerous Contracts
The Standard requires that if an entity has a contract
that is onerous, the present obligation under the
contract shall be recognized as a provision.
A contract in which the unavoidable costs of meeting
the contract obligation exceed the economic benefits
expected to be received under it.
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Application of the Recognition and
Measurement Principles
Provision for restructuring
Restructuring is a programme 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.

Examples are
 Sale or termination of a line of business.
 Closure of several plant.

 Changes in management structure.

Provision is recognized when constructive obligation

exists

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 Contingent Liabilities pg 754
Obligation that are only disclosed in the notes to
the accounts.
2 Types of Contingent Liabilities
1. Possible obligations arising 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.
2. Unrecognized present obligations arising from past
events 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 reliably.

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 UNRECOGNIZED PRESENT OBLIGATIONS

 A present obligation that is not recognized

because an outflow economic benefits
required to settle the obligation is less
probable than more probable (<50%
chance); or the amount cannot be reliably
measured

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PROVISIONS OR CONTINGENT LIABILITIES????
IF LIABILITIES > 50%
Make a Provision

IF LIABILITIES < 50%, > 5%

Disclose as Contingent Liabilities

IF LIABILITIES < 5%

No Action

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 Unrecognized Present Obligations-example 3

In early 2010, CIMB Bank granted Fendi Bhd a

3 year-bank loan of RM5,000,000. Aliff Bhd
stood as guarantor for the loan and will be
responsible for any default in payment by
Fendi.
In November 2012, Alif Bhd received a notice
from CIMB Bank, claiming that Fendi Bhd
owed the bank unpaid loan installments
together with late charges totaling RM500,000.
Fendi Bhd is expected not to be able to settle
the debt.

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Contingent Liabilities-solution
1.  Accounting treatment
As at the year-end 2010 and 2011, Aliff Bhd has no
present obligation to settle the debt of Fendi Bhd.
However, there is contingent liability – Aliff has a
possible legal obligation to make a settlement on behalf
of Fendi Bhd in the event of any default in payment.
Aliff Bhd will have to inform users of a contingent
liability of RM5,000,000 in the disclosure notes.

2. Journal entries
No journal entries required – disclose contingent
liability in disclosure notes to financial statements

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Provision-solution
 
1. Accounting treatment
As at the year-end 2012, Fendi Bhd is unable to settle its
debt. Aliff Bhd being the guarantor has a present obligation
due to a past event which may result in a probable outflow
of economic benefits. Thus, Aliff Bhd has to recognize an
expense of RM500,000 against the current profits and a
provision will be made on the statement of financial
position.

2. Journal entries
Dr. SOPL– operating expense 500,000
Cr. Provisions for damages 500,000

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 Contingent Assets pg 755
Possible assets that arise 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.

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 Contingent Assets
An entity shall not recognize a contingent
asset on SOFP

DISCLOSED in the notes to financial

statements?????
ONLY when an inflow of benefits is probable
(>50% chance)

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 Contingent Assets-example 4
In December 2012, Aznil Entertainment
filed a lawsuit of RM4,500,000 against
Jusco for using his image in Jusco’s
recent advertizing campaign.
A verdict was given in favor of Aznil but
the hearing to determine the amount of
damages will only be held in February
2013.

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 Contingent Assets
1. Accounting treatment
There is a possibility that Aznil will receive some
compensation damages from Jusco when a court
judgment is made the next year, which is beyond the
control of the company. The contingent asset is not
recognized in the financial statements (SOCI or SOFP)
because existence of the compensation is confirmed only
when a court decision is reached in the following year.
However, it will be disclosed in the disclosure notes to the
financial statements.

2. Journal entries
No journal entries required - disclosed in the disclosure notes to the
financial statements because favorable verdict

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Disclosure requirement

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Disclosure requirement

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Illustration
Tulip Bhd was incorporated in 2001 and has grown to become one of the largest plastic
manufacturers in Malaysia. In 2012, Tulip Bhd buried a large quantity of chemical waste it was
producing in a landfill. As a result, the land has been contaminated.

a. Describe when provisions should be recognized in accordance to MFRS 137 Provisions,

Contingent Liabilities and Contingent Assets.
(3 marks)

b. In each of the following scenarios, briefly explain whether or not Tulip Bhd would be
required to recognize a provision:

i. There is no legal requirement to clean up the land and Tulip Bhd has no record
of cleaning up land that it has been contaminated.

ii. There is a legal requirement to clean up the land.

iii. There is no legal requirement to clean up the land, but Tulip Bhd has a long record
of cleaning up the land that it has contaminated.
(3 marks)
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Illustration (3 marks)

a. In June 2014, 100 residents living near the landfill became seriously ill, possibly as a
result of exposure to the leaking toxic waste. Legal proceedings were commenced
seeking damages from Tulip Bhd, which disputed liability by claiming that the waste
buried by Tulip Bhd was responsible for the health problems of local residents.

As at the end of the reporting period of 31 December 2014, Tulip Bhd’s lawyers
advised that it was probable that Tulip Bhd would not be found liable.

Required:

i. Assess whether the legal case above is regarded as a provision or contingent

liability for Tulip Bhd based on MFRS 137 Provisions, Contingent Liabilities and
Contingent Assets.
(5 marks)

ii. Assuming that in 2015, the lawyers are of the opinion that, owing to the recent
development in the case, it is probable that the company will be found liable in
their disposal of waste. Tulip’s lawyers estimated the damages for the lawsuit
amounting to RM2 million. Explain the accounting treatment of this situation in
accordance to MFRS 137 Provisions, Contingent Liabilities and Contingent
Assets.
(5 marks)

iii. Show the journal entry to record the transaction in for situation (ii) above and the
extracts of the Statements of Financial Position of Tulip Bhd as at 31 December
2015.
(3 marks)
(Total: 20 marks)

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Solution
 
 
a. A provision should be recognized when:
 An entity has a present obligation from legal or constructive.
 It is possible a transfer of resources embodying economic benefits will be
required to settle it., and
 A reliable estimate can be made of its amount.
(3 √ = 3 marks)
b.
i. No present obligation√ – no provision. √
 
ii. Present obligation√- contamination of the land is the past event therefore a
provision should be recognised. √
 
iii. There is a constructive obligation√ – resulted from Tulip Bhd’s past actions√;
therefore a provision should be recognised. √
(7 √ = 7 marks) 38
 Solution
i.
 As at 31 December 2014, it is probable that the company will not be found
liable. √
 There is no present obligation √ as a result of past events. √
 Therefore, no provision is recognised. √
 The matter is disclosed as a contingent liability in the notes to the accounts. √
 

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Solution
ii.
 In 2015, it is probable that the company will be found liable. √
 Provision should be recognized for the damages√
 It is the present obligation√ for Tulip Bhd as a result of past events√
 Due to mismanagement in handling the disposal of waste, results
in lawsuit to Tulip Bhd.
 There is a reliable estimate of RM2 million√ on the provision would
also be the criteria for the company to recognize the provision of
damages.
 (5√ = 5 marks) 

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Solution  
iii. Show the journal entry for the above transaction and the extracts of
the financial statements for the year ended 31 December 2015.
 
Journal entry:
DR SOPL - Lawsuit expenses√ RM2,000,000√
CR. Provision for lawsuit√ RM2,000,000√
 
Statement of Financial Position as at 31 December 2014 (extract)
Non Current Liability:
Provision for Lawsuit RM2,000,000√
 
(3 √ = 3 marks)

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