Philippine Accounting Standards (PAS) 37 Provisions, Contingent Liabilities, and Contingent Assets PDF

In the context of the **Philippine Accounting Standards (PAS) 37**, which is based on **IAS 37**, the principles and guidelines for **provisions, contingent liabilities, and contingent assets** are largely aligned with their international counterpart. Here\'s a structured overview specific to PAS 37...

In the context of the **Philippine Accounting Standards (PAS) 37**, which is based on **IAS 37**, the principles and guidelines for **provisions, contingent liabilities, and contingent assets** are largely aligned with their international counterpart. Here\'s a structured overview specific to PAS 37: **Definition of Provisions under PAS 37** A **provision** is a liability of uncertain timing or amount. According to PAS 37, a liability is: 1. A present obligation (legal or constructive) arising from past events. 2. It is probable that an outflow of economic benefits will be required to settle the obligation. 3. The amount can be reliably estimated. **Recognition Criteria for Provisions** A provision should be recognized in the financial statements if **all** the following conditions are met: 1. **Present Obligation**: - A past event has created a legal or constructive obligation. - A **legal obligation** arises from contracts, laws, or other binding agreements. - A **constructive obligation** arises from an entity\'s actions, such as established practices or public statements, creating a valid expectation among others. 2. **Probable Outflow of Resources**: - It is more likely than not (i.e., greater than 50% probability) that resources embodying economic benefits will be required to settle the obligation. 3. **Reliable Estimate**: - The amount of the obligation can be reliably measured. If these criteria are not met, no provision is recognized. Instead, the obligation is disclosed as a contingent liability unless the possibility of outflow is remote. **Measurement of Provisions** - Provisions are measured at the **best estimate** of the expenditure required to settle the present obligation. - **Best Estimate**: - The amount that an entity would rationally pay to settle the obligation or transfer it to a third party at the reporting date. - If there is uncertainty, use a weighted average of possible outcomes (expected value). - Consideration of future events: - Future events, such as changes in law or technology, should be taken into account if there is sufficient objective evidence that they will occur. - **Discounting**: - If the effect of the time value of money is material, provisions are discounted to their present value using a pre-tax discount rate. **Common Examples of Provisions** 1. **Warranty Obligations**: Expected costs for warranties provided with products sold. 2. **Litigation Provisions**: Anticipated costs of legal disputes. 3. **Restructuring Provisions**: Costs related to an approved and announced restructuring plan. 4. **Environmental Provisions**: Costs to clean up or restore damage caused to the environment. 5. **Decommissioning or Restoration Costs**: Costs associated with the retirement of an asset. **Accounting for Provisions** 1. **Initial Recognition**: - **Journal Entry**: - Debit: Expense (e.g., Warranty Expense) - Credit: Provision for (specific liability) 2. **Settlement of the Obligation**: - When the obligation is settled, the provision is used: - Debit: Provision for (specific liability) - Credit: Cash/Bank or Other Payable Account 3. **Reversal of Unused Provisions**: - If it is no longer probable that an outflow of resources will be required: - Debit: Provision for (specific liability) - Credit: Reversal of Provision (Income) **Disclosure Requirements under PAS 37** Entities must disclose in their financial statements: 1. A brief description of the nature of the obligation. 2. The expected timing of any resulting outflows. 3. An indication of the uncertainties surrounding the amount or timing of outflows. 4. The carrying amount of the provision at the beginning and end of the reporting period, showing: - Additional provisions made. - Amounts used during the period. - Unused amounts reversed. 5. Any expected reimbursement, stating the amount and recognizing it separately as an asset. **Provisions vs. Contingent Liabilities** - **Provisions**: Recognized as liabilities when the recognition criteria are met. - **Contingent Liabilities**: Disclosed in the notes to the financial statements when: 1. There is a possible obligation from past events, but its existence will only be confirmed by future events. 2. There is a present obligation, but it is not probable that an outflow of resources will occur or the amount cannot be reliably estimated. ### **Example 1: Warranty Provisions** #### Problem: ABC Company sells electronic gadgets that come with a one-year warranty. Based on past experience, 5% of gadgets sold require repairs or replacements under the warranty. In 2024, the company sold 10,000 gadgets for ₱2,000 each. The average cost of fulfilling a warranty claim is estimated at ₱500. **Question**: How much provision for warranties should ABC Company recognize at the end of 2024? #### Solution: 1. **Determine the number of gadgets expected to require repairs:** 2. **Calculate the total cost of warranty claims:** 3. **Journal Entry to Record the Provision:** - Debit: Warranty Expense ₱250,000 - Credit: Provision for Warranty ₱250,000 4. **Disclosure**: - Nature of obligation: Warranty for products sold. - Carrying amount of provision: ₱250,000. ### **Example 2: Environmental Provision** #### Problem: XYZ Mining Corp. is legally required to restore land after its mining operations. Restoration costs are estimated at ₱5,000,000 to be paid in 10 years. The appropriate discount rate is 8%. **Question**: What amount should be recognized as a provision for restoration at the end of the current year? #### Solution: 1. **Determine the present value (PV) of the restoration cost:** Use the formula for present value: - Future Value = ₱5,000,000 - rr = 8% or 0.08 - nn = 10 years 2. **Journal Entry to Record the Provision:** - Debit: Environmental Restoration Expense ₱2,315,950 - Credit: Provision for Restoration ₱2,315,950 3. **Disclosure**: - Nature of obligation: Restoration of mining site. - Carrying amount of provision: ₱2,315,950. ### **Example 3: Litigation Provision** #### Problem: DEF Corporation is involved in a lawsuit. Legal counsel advises that it is **probable** the company will lose the case, and damages are estimated at ₱1,000,000. However, there is a 20% chance the loss could increase to ₱1,500,000. **Question**: How much provision should DEF Corporation recognize? #### Solution: 1. **Determine the best estimate:** - The probable outcome (₱1,000,000) is the most likely amount since it has an 80% chance of occurring. 2. **Provision Amount:** - The company should recognize ₱1,000,000 as the provision. 3. **Journal Entry to Record the Provision:** - Debit: Litigation Expense ₱1,000,000 - Credit: Provision for Litigation ₱1,000,000 4. **Disclosure**: - Nature of obligation: Expected settlement of lawsuit. - Carrying amount of provision: ₱1,000,000. - Uncertainty: 20% chance of increased damages to ₱1,500,000. Would you like to explore any of these examples in more detail?