IAS 37 Provisions and Contingent Liabilities
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Questions and Answers

What is the primary accounting entry when recognizing a provision?

  • Dr Asset, Cr Cash
  • Dr P/L, Cr Provision (correct)
  • Dr Provision, Cr Asset
  • Dr Cash, Cr P/L

In which scenario would an onerous contract most likely be recognized?

  • When future operating losses can be avoided
  • When the costs to fulfill exceed the expected benefits (correct)
  • When the expected benefits exceed the costs to fulfill
  • When the contract is deemed profitable

How is the discount for a provision unwound in accounting entries?

  • By debiting finance costs and crediting provisions (correct)
  • By crediting cash and debiting provisions
  • By recognizing an expense in P/L
  • By reversing the initial recognition in equity

What happens to a provision when a reimbursement is recognized?

<p>It is offset against the recognized reimbursement asset (D)</p> Signup and view all the answers

Which situation is NOT typically considered when recognizing provisions?

<p>Unprofitable franchises (A)</p> Signup and view all the answers

What must be established to determine if a provision should be made for the costs of cleaning up contamination?

<p>A reliable estimate of the cleaning costs (D)</p> Signup and view all the answers

In measuring provisions, what should the amount provided reflect?

<p>The best estimate of expenditure required to settle the obligation (B)</p> Signup and view all the answers

What is the practice regarding making reliable estimates in the context of provisions?

<p>It is generally expected to make reliable estimates (B)</p> Signup and view all the answers

Which describes the concept of 'most likely outcome' in the measurement of provisions?

<p>The outcome with the highest probability based on available evidence (C)</p> Signup and view all the answers

What should be considered when estimating a warranty provision?

<p>Expected values based on projected claims (D)</p> Signup and view all the answers

What is the primary purpose of creating an accounting standard?

<p>To avoid the manipulation of profits (D)</p> Signup and view all the answers

Which journal entry correctly reflects the reversal of a provision?

<p>Dr Provision (SOFP), Cr Expense (P/L) (D)</p> Signup and view all the answers

What defines a provision in accounting terms?

<p>A liability of uncertain timing or amount (C)</p> Signup and view all the answers

Which of the following must be assessed to recognize a provision?

<p>The probability of an outflow of resources (C)</p> Signup and view all the answers

A present obligation must arise from which of the following?

<p>Past events leading to a contractual obligation (C)</p> Signup and view all the answers

How should the recognition of a provision be recorded in financial statements?

<p>By debiting an expense and crediting the provision in the statement of financial position (A)</p> Signup and view all the answers

Which of the following is NOT a criterion for recognizing a provision?

<p>Expectations of future profit increases (D)</p> Signup and view all the answers

Which statement accurately describes a liability?

<p>It is a present obligation expected to result in an outflow of resources. (A)</p> Signup and view all the answers

What condition must be met for a provision to be recognized?

<p>An outflow is probable and can be measured (A)</p> Signup and view all the answers

Which of the following is NOT a reason to make a provision?

<p>Future operating losses (C)</p> Signup and view all the answers

What best describes a contingent liability?

<p>It is disclosed unless the probability of an outflow is remote (B)</p> Signup and view all the answers

When can a reimbursement be recognized in relation to a provision?

<p>Only when it is virtually certain to be received (D)</p> Signup and view all the answers

What is a decommissioning cost associated with?

<p>Cost related to acquisition and use of an oil rig (D)</p> Signup and view all the answers

What is the measurement basis for a provision?

<p>Best estimate of the amount of expenditure required (D)</p> Signup and view all the answers

Which of the following statements about contingent assets is true?

<p>They are disclosed if there is a probable inflow (B)</p> Signup and view all the answers

What characterizes a contingent liability?

<p>It represents a present obligation that may not result in an outflow. (D)</p> Signup and view all the answers

When should a contingent asset be disclosed?

<p>If the inflow of economic benefits is probable (A)</p> Signup and view all the answers

A provision is made when there is a present obligation due to which of the following?

<p>A past event (B)</p> Signup and view all the answers

Which of the following can lead to a reliable measurement of a provision?

<p>An expected value for a large population of items (A)</p> Signup and view all the answers

What does the term 'unwind the discount' refer to?

<p>Incrementally increasing the liability for future costs (C)</p> Signup and view all the answers

What condition might lead to a contingent liability not being recognized?

<p>The obligation cannot be reliably measured (C)</p> Signup and view all the answers

Which of the following best describes a present obligation?

<p>An obligation resulting from past events with a potential outflow (A)</p> Signup and view all the answers

What is included in the recognition of costs related to decommissioning?

<p>Dismantling and restoration costs of an asset (C)</p> Signup and view all the answers

How should a contingent liability be disclosed in financial statements?

<p>With a brief description and estimation of financial effect (A)</p> Signup and view all the answers

What is the main purpose of discounting decommissioning costs?

<p>To reflect the time value of money in costs (D)</p> Signup and view all the answers

Which scenario aligns with recognizing a contingent asset?

<p>Possible inflow due to uncertain future events (A)</p> Signup and view all the answers

Flashcards

Probable Outflow

A company is obligated to make an outflow of economic resources to settle a present obligation when it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.

Reliable Estimate

A reliable estimate can be made when the amount of the obligation can be measured reliably.

Best Estimate

The best estimate of the amount of the provision is the amount that the entity would rationally pay to settle the obligation at the end of the reporting period.

Expected Values

When there is a large population of items, the expected value method is used to estimate the provision. This method calculates the average of the probable outcomes weighted by their probabilities.

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Most Likely Outcome

When there is a single obligation, the most likely outcome method is used to estimate the provision. This method uses the most likely amount that the entity will pay to settle the obligation.

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Onerous Contract

A contract where the costs of fulfilling it are greater than the expected benefits.

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Provision

A liability of uncertain timing or amount, recognized in the financial statements when it is probable that a future outflow of resources will be required and a reliable estimate can be made.

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Unwind Discount

The process of adjusting a discount on a provision when the estimated future outflow of resources changes.

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Reimbursement

A repayment from a third party for a previously recognized provision, typically resulting in an asset and income recognition.

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Future Operating Losses

A scenario where a provision might be needed when a company anticipates future losses from its ongoing operations.

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Present Obligation

A legal or constructive obligation arising from a past event, where the entity has no realistic option to avoid performing the obligation.

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Constructive Obligation

An obligation that arises from an entity's actions that have created a valid expectation in an outside party that the entity will fulfill a promise or act in a certain way.

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Provision Recognition Criteria

A provision should be recognised only when: 1. There is a present obligation (legal or constructive) arising from a past event. 2. It's probable that an outflow of economic resources will be required to settle the obligation. 3. A reliable estimate of the amount of the obligation can be made.

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Example of a Provision

A manufacturer may recognize a provision for warranty costs if it's probable that customers will return faulty products and it can estimate the cost of repairs.

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Why do we need an accounting standard for provisions?

To avoid manipulation of profits. Without a standard, companies could create provisions and reverse them to smooth out profits over time, which can be misleading to users of financial statements.

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Impact of a provision on the Income statement

When a provision is recognized, an expense is recorded in the income statement, reducing the profit for the period.

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Impact of reversal of a provision on the income statement

When a provision is no longer needed, it's reversed, resulting in a credit entry in the income statement, increasing the profit for the period.

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Restructuring provision

A provision is recognized when it is a present obligation arising from a past event, it is probable that an outflow of economic benefits will be required to settle the obligation and the amount can be reliably measured. This is when a restructuring plan has either been implemented or announced.

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Decommissioning cost

Costs associated with taking an asset out of use. This includes dismantling, restoring, and removing the asset. Costs are recognized as an asset when it is brought into use and then depreciated over the life of the asset.

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Unwinding the discount

The process of increasing the decommissioning cost provision over the life of the asset to reflect the time value of money. This is done by gradually unwinding the discount rate applied to the present value of the future decommissioning costs.

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Contingent liability

A possible obligation from past events that is not recognized because either an outflow of economic benefits is not probable or the amount cannot be reliably measured.

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Disclose contingent liability

Even if a contingent liability is not recognized, it must still be disclosed in the financial statements if the outflow of economic benefits is not remote. This includes a brief description, the estimated financial effect, and the uncertainties.

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Contingent asset

A possible asset arising from past events whose existence will be confirmed by future uncertain events not wholly within the control of the entity.

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Disclose contingent asset

If an inflow of economic benefits is probable, the contingent asset must be disclosed in the financial statements. This includes a brief description, the estimated financial effect, and the uncertainties.

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Remote outflow

A contingent liability is not disclosed if the outflow of economic benefits is considered remote. This is when it is highly unlikely to occur.

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Measurement of Provisions

A provision is measured at the best estimate of the expenditure required to settle the obligation. If a range of possible outcomes exists, the most likely amount is used.

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Probability of Inflow

The likelihood of receiving future economic benefits from a contingent asset.

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Study Notes

IAS 37 Provisions, Contingent Liabilities and Contingent Assets

  • IAS 37 outlines the accounting for provisions, contingent liabilities, and contingent assets
  • It aims to avoid manipulation of profits
  • Provision: A liability of uncertain timing or amount
  • A present obligation arising from past events
  • Expected outflow of resources
  • Contingent Liability: A possible obligation that may arise from past events
  • Outflow of economic benefits is not probable
  • Obligation cannot be measured reliably
  • Disclosed only if the outflow is not remote
  • Contingent Asset: A possible asset resulting from past events
  • Inflow of economic benefits is probable
  • Disclosed only if the inflow is probable

Recognition Criteria for Provisions

  • Present Obligation: Does the entity have a legal or constructive present obligation arising from a past event?
  • Probable Outflow: Is an outflow of economic resources probable?
  • Reliable Estimate: Can a reliable estimate be made of the amount of outflow?

Measurement of Provisions

  • Amount provided should be the best estimate at the end of the reporting period
  • Consider the expected values of a large population of items
  • Consider the most likely outcome of a single obligation
  • Follow IAS 37 measurement guidance

Accounting Entries for Provisions

  • Recognize provision: Debit expense/asset, credit provision
  • "Unwind discount": Debit finance cost, credit provision
  • Use provision: Debit provision, credit cash
  • Reverse provision: Debit provision, credit expense/P&L

Specific Scenarios

  • Future operating losses
  • Onerous contracts
  • Restructuring
  • Repairs and maintenance
  • Decommissioning costs
  • Self-insurance
  • Examples, such as warranties, legal claims, and environmental contamination, are often used throughout slides to illustrate provisions and contingent liabilities

Reimbursements

  • Provision recognized by the reporting entity
  • The provision is offset by an income or asset

Contingent Liabilities

  • Disclose if the outflow is not remote
  • Provide brief description
  • Give estimated financial effect
  • Include indication of uncertainty
  • Show possibility of reimbursement

Contingent Assets

  • Disclose if an inflow is probable
  • Provide brief description
  • Provide estimated financial effect

Summary

  • IAS 37 provides a framework for accounting for provisions, contingent liabilities, and contingent assets. This is important to prevent manipulation of financial statements and ensure accurate reflection of a company's obligations and potential gains.

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IAS 37 Provisions, Contingent Liabilities and Contingent Assets PDF

Description

This quiz explores IAS 37, which details the accounting for provisions, contingent liabilities, and contingent assets. Learn about key concepts including present obligations, probable outflows, and the criteria for recognizing provisions. Test your understanding of these essential accounting principles.

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