Chap 4

• Provision


  An existing liability of uncertain timing or uncertain amount
• Provision


  • The essence of a provision is that there is uncertainty about the timing or amount of the future expenditure
  • The liability definitely exists at the end of reporting period but the amount is indefinite or the date when the obligation is due is also indefinite, and in some cases, the payee cannot be identified or determined
  • 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 of provision


  1. The entity has a present obligation, legal or constructive, as a result of a past event

  2. It is probable that an outflow of resources embodying economic benefits would be required to settle the obligation

  3. The amount of the obligation can be measured reliably
• Present obligation


  • A legal obligation is an obligation arising from a contract, legislation or other operation of law
  • A constructive obligation is an obligation that is derived from an entity's actions where the entity has indicated to other parties that it will accept certain responsibilities by reason of an established pattern of past practice, published policy, or a sufficiently specific current statement, and as a result, the entity has created a valid expectation on the part of other parties that it will discharge those responsibilities
• Past event


  • The past event that leads to a present obligation is called an obligating event
  • An obligating event is an event that creates a legal or constructive obligation because the entity has no realistic alternative but to settle the obligation created by the event
• Probable outflow of economic benefits

  • For a provision to qualify for recognition, there must be a probable outflow of resources embodying economic benefits to settle the obligation
  • An outflow of resources is regarded as probable if the event is more likely than not to occur, i.e. the probability that the event will occur is greater than the probability that it will not occur
• Reliable estimate


  • The use of estimate is an essential part of the preparation of financial statements and does not undermine their reliability
  • Where no reliable estimate can be made, no liability is recognized
• Measurement of provision


  1. The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of reporting period

  2. Where a single obligation is being measured, the individual most likely outcome adjusted for the effect of other possible outcomes may be the best estimate

  3. Where there is a continuous range of possible outcomes and each point in that range is as likely as any other, the midpoint of the range is used

  4. Where the provision being measured involves a large population of items, the obligation is estimated by "weighting all possible outcomes by their associated possibilities" (expected value)
• Risks and uncertainties


  • The risks and uncertainties that inevitably surround events and circumstances shall be taken into account in reaching the best estimate of a provision
  • Risk describes variability of outcome
  • A risk adjustment may increase the amount at which a liability is measured
• Present value of obligation


  • Where the effect of the time value of money is material, the amount of provision shall be the present value of the expenditure expected to settle the obligation
  • The 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
• Future events


  Future events that affect the amount required to settle an obligation shall be reflected in the amount of a provision where there is a sufficient evidence that they will occur
• Gain from expected disposal of asset shall not be taken into account in measuring a provision
• Reimbursements


  • Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognized when it is virtually certain that reimbursement would be received if the entity settles the obligation
  • The reimbursement shall be treated as a separate asset and not netted against the estimated liability for the provision
• Changes in provision


  1. Provisions shall be reviewed at every end of the reporting period and adjusted to reflect the current best estimate

  2. The provision shall be reversed if it is no longer probable that an outflow of economic benefits would be required to settle the obligation

  3. Where discounting is used, the carrying amount of the provision increases each period to reflect the passage of time
• Use of provision


  A provision shall be used only for expenditures for which provision was originally recognized
• Provision shall not be recognized for future operating losses
• Onerous contract


  • If an entity has an onerous contract, the present obligation under the contract shall be recognized and measured as a provision
  • An onerous contract is a contract in which the unavoidable costs of meeting the obligation under the contract exceed the economic benefits expected to be received under it
• Examples of provision


  • Warranty
  • Environmental contamination
  • Decommissioning or abandonment cost
  • Court case
  • Guarantee
• Restructuring


  Restructuring is a program that changes either the scope of a business of an entity or the manner in which that business is conducted, and is planned and controlled by management and materially changes the entity's operations
• Recognition of the provision for restructuring

  A constructive obligation for restructuring arises when the entity has a detailed formal plan for the restructuring and has raised 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 of restructuring provision

  A restructuring provision shall include only direct expenditures arising from the restructuring, and shall not include costs of retraining or relocating continuing staff, marketing or advertising programs, or investment in new systems and distribution networks
• Contingent liability


  A contingent liability is 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, or a present obligation that arises from past event but is not recognized 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
• Contingent asset


  • A contingent asset is 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
  • A contingent asset shall not be recognized because this may result to recognition of income that may never be realized
• Decommissioning liability


  A decommissioning liability is an obligation to dismantle, remove and restore an item of property, plant and equipment as required by law or contract
• Change in decommissioning liability

  1. A decrease in the liability is deducted from the cost of the asset, and any excess over the carrying amount is recognized in profit or loss

  2. An increase in liability is added to the cost at the asset, and the entity shall consider whether this is an indication that the carrying amount of the asset may not be fully recoverable