Provisions, Contingent Liabilities and Contingent Assets BAS 37
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Provisions, Contingent Liabilities and Contingent Assets [Bangladesh Accounting Standard (BAS) 37]
Provisions, Contingent Liabilities andContingent Assets [Bangladesh Accounting Standard (BAS) 37]
ObjectivesScopeImportant DefinitionsRecognitionMeasurementChanges in ProvisionsUse of ProvisionsReimbursementDisclosuresContents
BAS 37ObjectivesTo prescribe the criteria for recognition and measurement of
ProvisionContingentAssetsContingentLiabilitiesTo prescribe the criteria for using the provision and changes of provision
To prescribe the disclosure requirements
This Standard shall be applied by all entitiesin accounting for provisions, contingentliabilities and contingent assets, except those covered by other Standards, such as:
- BAS 11- BAS 12- BAS 17- BAS 18- BAS 19- BAS 39- BFRS 4 etc.
Accrual concept of accounting implies that business transactions should be recoded in the book of accounts as and when it meets the recognition criteria.
Matching concept implies that expenses for a particular period should be matched against the revenues earned in that period to determine the performance the of the business in that particular period.Accrual Vs. Matching
-is a liability of uncertain timing or amountProvision
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
A legal obligation is an obligation that derives from:
(a) a contract (through its explicit or implicit terms);(b) legislation; or(c) other operation of law.
A constructive obligation is an obligation that derives from an entitys actions where:
(a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and
(b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.
Entity ABC does not have a contract in place that states that employees are entitled to a bonus (in the form of a 13th cheque), however it has been the entitys practice for the last few years to pay bonuses to employees in December. Entity A has a constructive obligation to pay bonuses that was created due to its past practices.
A contingent liability is:
a possible obligation that arises 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; or
a present obligation that arises from past events but is not recognized because:
it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; orthe amount of the obligation cannot be enasured with sufficient reliability.
A contingent asset is a possible asset that arises 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 entityContingent asset
The difference between provisions and other liabilities is that there is uncertainty about the timing or amount needed to settle the obligation. By contrast:
Payables, where the goods and services have been invoiced or formally agreed with the supplier; and
Accruals, where the goods and services have been received but have not been invoiced or formally agreed with the supplier, including amounts due to employees. Although the amount or timing may need to be estimated, there is much less uncertainty involved.
Accruals should be reported as part of trade and other payables, whereas provisions are reported separately in the statement of financial positionProvision vs. Payables & Accruals
Entity ABCs leave policy states:
If an employee does not take his/her leave within one year of it accumulating to him/her, the outstanding leave days will be paid out in cash at the end of that year.
In the above case, when the leave is accrued to the employee, management is bound to compensate (through its policy) the employee for the leave. There is no uncertainty of timing or amount. Economic benefits will flow out as a result of this leave. This leave should be accounted for as an accrual.
Entity ABCs leave policy states:
Any unused leave will be forfeited if not used within six months after the annual leave cycle has expired.
In this case, timing is certain (within six months after the annual leave cycle has expired), but the amount may be uncertain (i.e. an estimate of the leave that will be forfeited should be made in measuring the liability). Management should use its judgment in deciding whether the uncertainty is more or less in measuring the liability, the preceding is true, then the leave liability should be recognized as a provision.Example.cont.
When to recognize a provision?Present obligationProbable outflowReliable estimate
All conditions met?YesNoRecognize provisionEither contingent liability or nothing
An entity in the oil industry causes contamination but cleans up only when required to do so under the laws of the particular country in which it operates. One country in which it operates has had no legislation requiring cleaning up and the entity has been contaminating land in that country for several years. At 31 December 2015, it is virtually certain that a draft law requiring a clean-up of land already contaminated will be enacted shortly after the year end.
Is there a present obligation? The obligating event is the contamination of the land because of the virtual certainty of legislation requiring cleaning up.Is there a probable transfer of economic benefits? Yes, probable.Conclusion- A provision is recognized for the best estimate of the costs of the clean-up.
On 12 December 2015, the board of an entity decided to close down a division making a particular product. On 20 December 2015 a detailed plan for closing down the division was agreed by the board. Letters were sent to customers warning them to seek an alternative source of supply and redundancy notices were sent to the staff of the division.
Is there a present obligation as a result of a past obligating event?
The obligating event is the communication of the decision to the employees, which gives rise to a constructive obligation from that date because it creates a valid expectation that the division will be closed.
Is there an outflow of resources embodying economic benefits in settlement?
A provision is recognised at 31 December 2015 for the best estimate of the costs of closing the division.
ContingenciesContingent LiabilityContingent AssetDo not recognize but discloseOutflow possible (but not probable)Outflow remoteDo not recognize and no disclosureDo not recognize but discloseInflow is probableNothing In other cases
Contingent liabilities should be reviewed continuously to determine if the outflow of resources have become probable. A provision is raised in the financial statements in the period in which the outflow of resources becomes probable.
Review of contingent liabilities
Entity A terminated the employment of one of its employees. A few months after the termination, the employee sued Entity A for unfair dismissal. At reporting date, 30 June 2010, the attorneys of Entity A advised that the entity will probably not be held liable. There were some developments in the case and by the next reporting date the attorneys advised the entity that they will probably be found liable.Example
Accounting treatment as at 30 June 2014
It is not probable that the entity will be liable thus no provision will be made, however there is a possible obligation due to a past event (dismissal) that will only be confirmed by the occurrence or non-occurrence of an uncertain future event (outcome of the court case). Hence the entity has to disclose a contingent liability at 30 June 2014.Examplecont
Accounting treatment at 30 June 2015
At this reporting date it is probable that the entity will be liable and therefore a provision is recognized. The provision will be measured as the best estimate of the amount required to settle the obligation. Note that the provision recognized at 30 June 2015 will not be accounted for retrospectively, i.e. by adjusting comparative figures as the circumstances changed (new information came to light) only in the current period.
The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the reporting date.
The best estimate is normally the amount that the entity would rationally pay to settle the obligation or to transfer it to a third party at reporting date. These estimates are based on judgments by management and these judgments are supported by experience of similar transactions and, in some cases, reports from independent experts. Any events after reporting date should also be considered and included.
Uncertainties surrounding the amount to be recognized as a provision are dealt with by various means according to the circumstances, for example:
Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, then the midpoint of the range is used; alternatively;
Where the provision measured involves a large population, the obligation is estimated by weighting all possible outcomes by the associated probabilities. This statistical method of estimation is referred to as the expected value; and
For a single item, the most likely outcome is the best estimate.
For example, An entity sells goods with a warranty under which customers are covered for the cost of repairs of any manufacturing defects that become apparent within the first six months after purchase. If minor defects were detected in all products sold, repair costs would be Tk. 1 million. If major defects were detected in all products sold, repair costs would be Tk. 4 million. The entitys past experience and future expectations indicate that, for the coming year, 75 per cent of the goods sold will have no defects, 20 per cent of the goods sold will have minor defects and 5 per cent of the goods sold will have major defects.
The expected value of the cost of repairs is:
(75% of nil) + (20% of 1m) + (5% of 4m) = Tk. 400,000
Changes in provision
Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision shall be reversed.
Where discounting is used, the carrying amount of a provision increases in each period to reflect the passage of time. This increase is recognized as borrowing cost.
Use of provision
A provision shall be used only for expenditures for which the provision was originally recognized.
Only expenditures that relate to the original provision are set off against it. Setting expenditures against a provision that was originally recognized for another purpose would conceal the impact of two different events.
Sometimes it happens that when a provision is settled that some or all of the expenditure is to be reimbursed by a third party. The reimbursement should only be recognized, as income and a corresponding asset, when it is virtually certain that the reimbursement will be received.
The amount recognized for the reimbursements shall not exceed the amount of the provision.
In the statement of financial performance the expense relating to the provision may be presented net of the amount recognized as a reimbursement.
For each class of provision, an entity shall disclose:
the carrying amount at the beginning and end of the period;additional provisions made in the period, including increases to existing provisions;amounts used (i.e. incurred and charged against the provision) during the period;unused amounts reversed during the period; andthe increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate.
An entity shall disclose the following for each class of provision:
a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits;an indication of the uncertainties about the amount or timing of those outflows. Where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events; andthe amount of any expected reimbursement, stating the amount of any asset that has been recognized for that expected reimbursement.
Unless the possibility of any outflow in settlement is remote, an entity shall disclose for each class of contingent liability at the end of the reporting period a brief description of the nature of the contingent liability and, where practicable:
an estimate of its financial effect measured;an indication of the uncertainties relating to the amount or timing of any outflow; andthe possibility of any reimbursement.
In extremely rare cases, disclosure of some or all of the information required by paragraphs 8489 can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the provision, contingent liability or contingent asset. In such cases, an entity need not disclose the information, but shall disclose the general nature of the dispute, together with the fact that, and reason why, the information has not been disclosed.
Thank You for Your AttentionAny Questions?
Amin Siddiki FCA