ACCT3321 Lecture Notes - Lecture 5: Financial Statement, Book Value, Contingent Liability
CHAPTER 8
Provisions, contingent liabilities and contingent assets
Definition of a provision
- Paragraph 49(b) of the conceptual framework defines a liability as:
oA 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 provision is a subset of liabilities
oA liability of uncertain timing or amount
- It must have a present obligation
oAn obligation is a duty or responsibility to act or perform in a certain way
oMay be enforceable by a contract…
oOnly exists where the entity has no realistic alternative but to make the
sacrifice of economic benefits to settle the obligation
- Constructive obligation – p 3
-Distinguishing provisions from other liabilities
oMay arise from either a legal or constructive obligation
oThe key distinguishing factor is the uncertainty relating to either the timing of
settlement or the amount to be settled
oTrade payable – are liabilities to pay for goods or services that have been
received or supplied and have been invoiced or formally agreed with the
supplier
oAccruals – are liabilities to pay for goods or services that have been received
or supplied but have not been paid, invoiced or formally agreed with the
supplier, including amounts due to employees. Although sometimes
necessary to estimate amounts and timing
oBenefits are not included
-Recognition criteria
oSame as liabilities
oA provision is recognised when:
An entity has a present obligation as a result of a past event
It is probably that an outflow of resources embodying economic
benefits will be required to settle the obligation
A reliable estimate can be made of the amount of the obligation
Example p6
oLegal obligation – settlement of the obligation enforced by law
oConstructive obligation – the event needs to create a valid expectation in
other parties that the entity will discharge the obligation
an obligation that derives from an entity’s 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
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those other parties that it will discharge those responsibilities.
Paragraph 72 of AASB 137 detailed formal plan and valid
expectation
-Measurement of provisions
oBest estimate
Is the amount that represents, as closely as possible, what the entity
would rationally pay to settle the present obligation at the end of the
reporting period
Uncertainties – the provision will be different depending on whether
the probability of loss of a given amount is X% or Y%
The provision is measured before tax
oRisks and uncertainties
Must be taken into account
Risk = variability of outcome
oPresent value
Provisions are required to be discounted to present value
The higher the discount rate, the lower the amount that will be
recognised as a liability
An easier way to factor risk is to use it in assessing the probability of
outcomes and then use a risk-free rate in discounting cash flows
oFuture events
Must be taken into account
oExpected disposal of assets
Must not be taken into account, even if the disposal is closely linked
to the event giving rise to the provision
oReimbursements
Can only be recognised as an asset when it is virtually certain that the
reimbursement will be received if the entity settles the obligation
Differing from the definition of an asset
oChanges in provisions and use of provisions
provisions must be reviewed at the end of the 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 should be reversed
where discounting is used, the carrying amount of a provision
increases in each period to reflect the passage of time borrowing
cost
example 8.3
Definition of a contingent liability
- Paragraph 10 of AASB 137…
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Document Summary
A provision is a subset of liabilities: a liability of uncertain timing or amount. Although sometimes necessary to estimate amounts and timing: benefits are not included. Recognition criteria: same as liabilities, a provision is recognised when: An entity has a present obligation as a result of a past event. It is probably that an outflow of resources embodying economic benefits will be required to settle the obligation. A reliable estimate can be made of the amount of the obligation. Paragraph 72 of aasb 137 (cid:0) detailed formal plan and valid expectation. Is the amount that represents, as closely as possible, what the entity would rationally pay to settle the present obligation at the end of the reporting period. Uncertainties the provision will be different depending on whether the probability of loss of a given amount is x% or y% The provision is measured before tax: risks and uncertainties. Risk = variability of outcome: present value.
