Similarly, if Rey Co has to pay to install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8, so no provision is required. IAS 37 Provisions Contingent Liabilities and Contingent Assets Overview. The second issue consideration is which costs should be included within the provision. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. In summary, IAS 37 is a key standard for FR candidates. Rey Co gives a year’s warranty with all goods sold during the year. Rey Co has a cost of capital of 10%. IAS 37 â Example (restructuring) â ACCA Financial Reporting (FR) IAS 37 full text Outlines the accounting for: (IAS 37 definition) Provisions ; is a liability with uncertain timing or amount. Rey Co could delay the work until 20X9, or sell the building. In other words, if there is no past event, then there is no liability and no provision should be recognized. Subsequently, the discount on this provision would be unwound over time, to record the provision at the actual amount payable. IAS 37 Provisions, Contingent Liabilities and Contingent Assets contains requirements on how to measure decommissioning, restoration and similar liabilities. The unwinding of this discount would be recorded in the statement of profit or loss as a finance cost. The chief accountant of Rey Co has reviewed the profit to date and realises they are likely to achieve profits of $13m. In this case, Rey Co would provide $10m, being the most likely outcome. Therefore there is no present obligation to incur the costs associated with this. This is effectively an attempt to move $3m profit from the current year into the next period. He also knows that the profit target will be set at $14m in the next year. FREE Courses Blog. with a ⦠In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. For example, in the case of an insurance claim where Rey Co can show they have cover. If it appears that there is a possible outflow then no provision is recorded. IAS 33 Rights Issue. Similarly, if Rey Co has to pay to install new safety equipment in the factory in 20X9, there is no present obligation to do this in 20X8, so no provision is required. These costsshould exclude any costs associated with any continuing activities. The unwinding of this discount would be recorded in the statement of profit or loss as a finance cost. Over the useful life of the asset, the $170m will be depreciated. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce the profit down to $10m. The exception to this is if an entity creates an obligation for future costs due to the construction of a non-current asset. 1. However, it has come to light that Rey Co may have a counter claim against the manufacturer of the machinery. Even though there is a similar likelihood that Rey Co would win the counterclaim, this is a probably inflow and therefore only a contingent asset can be recorded. Rey Co gives a yearâs warranty with all goods sold during the year. By 31 December 20X9, when Rey Co is required to make the payment, the liability should be showing at $10m, not $9.09m. Even though there is a similar likelihood that Rey Co would win the counterclaim, this is a probably inflow and therefore only a contingent asset can be recorded. This is because the event arose in 20X8 which could lead to an obligation. IAS 27 Separate Financial Statements. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. During 20X8, Rey Co opened a new factory, leading to some environmental damage. Free sign up Sign In. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. He also knows that the profit target will be set at $14m in the next year. In addition to this, the expected timing of when the event should be resolved should also be included. IAS 37 â provisions and contingent liabilities â ACCA Financial Reporting (FR) Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation. On 31 December 20X8, Rey Co should record the provision at $10m/1.10, which is $9.09m. IAS® 37 appears to be less popular than other standards because, usually, answers to Financial Reporting (FR) questions required a balanced discussion of whether criteria are met, as opposed to calculating numbers. Therefore there cannot be included in the financial statemets. According to IAS 37, 3 criteria are required to be met before a provision can be recognised. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. The first is to assess whether an obligation exists at the reporting date. the entity has a present obligation. They believe there is a 10% chance of having to pay $12m, and a 10% chance of paying nothing. This is where IAS 37 is used to ensure that companies report only those provisions that meet certain criteria. Rey Co has a consistent history of honouring this policy. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. Rey Co has a published environmental policy. The accountant knows that if Rey Co reports a profit of $13m, directors will not get any more of a bonus than if they reported $10m. Onerous contracts are those in which the costs of meeting the contract will exceed any benefits which will flow to the entity from the contract. review IAS 37 standard's disclosure requirements. This article will consider the aims of the standard, followed by the key specific criteria which must be met for a provision to be recognised. However, IAS 37 is often a key standard in FR exams, and candidates must be prepared to wrestle with applying the criteria. To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of $3m, with the impact of making the profit seem lower in the current period. Standard also deals with reimbursements of provisions by another party, changes in provisions and use of provisions. During this training session the participants will obtain a comprehensive understanding of the detailed requirements of these standards. This rule has two parts, first the type of obligation, and second, the requirement for it to come from a past event (something must have already have happened to create the obligation). 6:22. Rey Co estimate that the damage will cost $400,000 to restore. Which of the following statements about the requirements of IAS 37 Provisions, contingent liabilities and contingent assets are correct? The definition of a provision is key to the standard. Finally, it will examine some specific issues which are often assessed in relation to the standard. Restructuring costs associated with reorganising divisions provide two issues. This rule has two parts, first the type of obligation, and second, the requirement for it to come from a past event (something must have already have happened to create the obligation). As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. The global body for professional accountants, Can't find your location/region listed? In addition to this, the expected timing of when the event should be resolved should also be included. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. Here, the provision would be measured at $60k. The table below shows the treatment for an entity depending on the likelihood of an item happening. Even if the country has no legal regulations forcing Rey Co to replant trees, Rey Co will have a constructive obligation because it has created an expectation from its publications, practice and history. These are: These criteria will now be examined in further detail to see how they can be applied in practice. Therefore there cannot be included in the financial statemets. IAS 37 standard sets out the recognition, measurement and disclosure requirements of provisions, and it also deals with contingent assets and contingent liabilities. The final criteria required is that there needs to be a probable outflow of economic resources. IAS 37 sets out how to account for the credit risk of the entity IAS 37 does not give any guidance on non-performance risk by the entity In the case of IAS 37, the risk adjustment would measure the amount that it would cost to be free of risk Several existing IFRSs specify the types of costs that should be included in measuring an item. In this case, Rey Co would include a provision for the $10m loss in liabilities. Therefore there is no present obligation to incur the costs associated with this. This quiz will help you cover the theoretical and conceptual aspects of IAS 37 Provisions and Contingencies. Free sign up Sign In. The key difference is that a contingent asset is only recorded if there is a probable future inflow, rather than a possible one. This is where a company establishes an expectation through an established course of past practice. Rey Co could not provide for any possible claims which may arise from injuries in the future. Rey Co’s legal advisors continue to believe that it is likely that Rey Co will lose the court case against the employee and have to pay out $10m. ... ACCA ⦠IAS 19 Employee Benefits. ACCA P2 Provisions, contingent assets and liabilities (IAS 37) Free lectures for the ACCA P2 Corporate Reporting Exams ACCA CIMA CPD FIA (ACCA) AAT. All subject exam questions. Finally, it will examine some specific issues which are often assessed in relation to the standard. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want. In an exam, it is unlikely that there will not be a reliable estimate. As soon as an entity is aware that a contract is onerous, the full loss should be provided for as a liability in the statement of financial position. As part of obtaining permission to construct the platform, Rey Co has a legal obligation to remove the asset at the end of its useful life. To address inconsistencies with other IFRSs. For example, in the case of an insurance claim where Rey Co can show they have cover. This e-learning course is part of an e-learning series designed by PwC Academy Hungary which aims to provide a comprehensive overview of the application of IFRS (IAS) standards to finance and accounting experts who are already familiar with fundamental (local) accounting and reporting processes. Candidates are required to learn the three key criteria for a provision, as they are likely to have to explain these in an exam. If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. You are just about to attempt the quiz about the IAS 37 Provisions and Contingencies. IAS 12 Income Taxes. A probable outflow simply means that it is more likely than not that the entity will have to pay money out. C2. IFRS 3 Business Combinations . This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. Again, a description of the event should be recorded in addition to any potential amount related to this. There is no double entry recorded in respect of this. Likewise it is unlikely that an entity will be able to avoid recording a liability when there is an obligation by claiming there is no way of producing an estimate of the amount. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. Please visit our global website instead. probable ( >50% ) outflow of resources. Past experience shows that Rey Co needs to do no repairs on 85% of the goods. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. Rey Co’s manufacturing manager has calculated that if minor repairs were needed on all goods it would cost $100,000, and major repairs on all goods would cost $1m. If it appears that there is a possible outflow then no provision is recorded. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce the profit down to $10m. IAS 37 â Provisions, Contingent Liabilities and Contingent Assets Quiz Free IFRS Quizzes IAS 37 â Provisions, Contingent Liabilities and Contingent Assets Quiz ) , () ) Previous Lesson. C2. In this situation, a contingent liability would be reported. IAS® 37 appears to be less popular than other standards because, usually, answers to Financial Reporting (FR) questions required a balanced discussion of whether criteria are met, as opposed to calculating numbers. The IASB has initiated a project to replace IAS 37 for three main reasons: 1. The key here is whether the restructuring has been announced to the affected employees. In this case, Rey Co would include a provision for the $10m loss in liabilities. IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. This quiz is a sample of our larger question bank of 50+ questions on IAS 37. It can be seen here that Rey Co could only recognise an asset from a potential inflow if it is virtually certain. The legal advisors believe that there is an 80% chance that the counter claim against the manufacturer is likely to succeed, and believe that Rey Co would win $8m. Rey Co has received legal advice that the most likely outcome of the court case from the employee is that they will lose the case and have to pay $10m. To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of $3m, with the impact of making the profit seem lower in the current period. Back to Course Next Lesson. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. This is effectively an attempt to move $3m profit from the current year into the next period. Therefore any provision should only include items such as redundancies and closure costs. The second type of obligation is one called a constructive obligation. Rey Co could delay the work until 20X9, or sell the building. Here, Rey Co would capitalise the $170m as part of property, plant and equipment. If the item is made up of a number of items, such as a warranty provision for repairing goods, the expected value should be calculated using the probability of all events happening. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. This is because the event arose in 20X8 which could lead to an obligation. Written by a member of the Financial Reporting examining team, Virtual classroom support for learning partners, IAS 37 – Provisions, contingent liabilities and contingent assets, There needs to be a present obligation from past event. The key here is whether the restructuring has been announced to the affected employees. In addition to this, the discount on the provision will be unwound and the provision increased each year. Provisions from past papers in ACCA FR (F7). IAS 37 stipulates the criteria for provisions, contingent liabilities and contingent assets which must be met in order for a provision to be recognised, so that companies should be prevented from manipulating profits. A contingent liability is simply a disclosure note shown in the notes to the accounts. If the employees have been informed, then an obligation exists and a provision must be made. Note: Your answer should briefly set out the nature of financial capital in integrated reports. The legal team think there is an 80% chance of this. ... 37. The second issue consideration is which costs should be included within the provision. Please visit our global website instead, Can't find your location listed? The changes proposed in ED/2018/2 Onerous Contracts â Cost of Fulfilling a Contract (Proposed amendments to IAS 37) 1. specify that the âcost of fulfillingâ a contract in paragraph 68 of IAS 37 comprises the âcosts that relate directly to the contractâ; and 2. provide examples of costs that do, and do not, relate directly to a contract to provide goods or services. To understand provisions better, letâs break down the definition of a liability in IAS 37: A liability is a present obligation arising from past event that is expected to be settled by an outflow of economic benefits from an entity. Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. ACCA CIMA CAT DipIFR Search. If the employees have not been informed, then the company could change its mind. Therefore the liability is increased by 10% over the year, giving an increase of $910k which would be recorded in finance costs. At 31 December 20X8, the legal advisors of Rey Co now believe that the $10m payment from the court case would be payable in one year. IAS 37 Provisions, Contingent Liabilities and Contingent Assets â ACCA (FA) lectures Spread the word Please spread the word so more students can benefit from our study materials. 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