IA2 - PROVISION
PROVISION - there is an existing liability at an
uncertain amount and timing.
- it is the uncertainty that
distinguishes provision from liabilities.
- equivalent to estimated liability or
loss on contingency that is accrued because both
are probable and can be measured reliably.
What is certain in a provision?
- there is a liability at the end of the reporting
period.
What is not certain in a provision?
- no date of settlement
- no certain amount
- no payee (sometimes)
RECOGNITION OF PROVISION
Under PAS 37, paragraph 14
1. The entity has present obligation
- may be legal or constructive resulting from
past event
2. It is probable that outflow of resources will
occur.
- economic resouces will be used to settle
the obligation.
3. The amount of the obligation
can be measured reliably.
Present obligation
LEGAL - arising from contract, legislation, or
other operation of law. + Article 1157
CONSTRUCTIVE - established from a pattern of
practice or stated policy of the entity that has create
a valid expectation from customers and that it will
accept certain responsibilities.
Past event
- OBLIGATING EVENT - past event that leads to
present obligation
- NO accounting provision can be created in
anticipation of future event.
- creates legal or constructive obligation because
the entity has no other alternative but to settle the
obligation.
Probable outflow of economic benefits
PROBABLE - event is more likely to occur than
not to occur; more the 50% chance of occurrence
POSSIBLE - 50% or less likely to occur
REMOTE- 10% or less likely to occur
Reliable estimate
PAS 37, paragraph 25
- By using a range of possible outcomes, an entity
can make a reliable estimate of the obligation.
- When no reliable estimate can be made, NO
liability.
Measurement of provision
BEST ESTIMATE - the amount an entity would
rationally pay to settle a liability at the end of the
reporting period or to transfer it to a third party at
that time.
Best estimate for single obligation
- the individual most likely outcome adjusted
for the effect of the other possible outcomes.
Continuous range of possible outcomes
- midpoint range is used; other points are
likely like any other. (100K to 500k;
100,000 + 500,000 /2)
Large population
- “weighting” all possible outcomes with
their associated possibilities.
Expected value method
- Expected value or cost of repairs is
measured by weighing all possible outcomes
by their associated probabilities.
Discounting provisions
- An amount of provision is discounted if the
time value of the provision is material.
Other measurement considerations
1. Risk and uncertainties
2. Present value of the obligation
3. Future events
4. Expected disposal of assets
5. Reimbursements
6. Changes in provision
7. Use of provision
8. Future operating losses
9. Onerous contract
Risk and uncertainties
RISK - variability of outcomes
RISK ADJUSTMENT – may increase the amount
at which a liability is measured.
 must be exercised with PRUDENCE.
- PRUDENCE – caution not to overestimate
income and assets and not underestimate
liabilities and expenses.
- Uncertainty does not justify creation of
excessive provision or a deliberate
overstatement of liabilities.
Present value of obligation
If time value of provision is MATERIAL
-
-
Provision measured at present value of
expenditure expected to settle the obligation.
Discount rate should be pretax rate that
should reflect the current market assessment
of the (1) time value of money and (2) risk
specific to the liability.
Discount rate should not reflect the risk for
which cash flow estimates have already
been adjusted.
Future events
- should be reflected in the amount of
provision
- FUTURE EVENTS – events that may affect
the amount required to settle an obligation
- Ex. New legislations and changes in
technology
- There is sufficient evidence that such event
will occur.
Expected disposal of asset
- Cash inflows from disposal of an asset is
treated SEPARATELY from measurement
of provision.
- NOT considered in measuring provision.
- Entity shall recognize GAIN ON
DISPOSAL OF ASSET on disposition of
asset.
Reimbursements
- When SOME or ALL of the expenditure is
to be reimbursed by another party, the
reimbursement shall be recognized when it
is virtually certain that reimbursement will
be received if entity settles the obligation.
- Separate ASSET
- NOT netted against estimated liability for
the provision
- Reimbursement shall NOT exceed amount
of provision
- PRESENTATION IN INCOME
STATEMENT – expense net of
reimbursement
Changes in provision
- Provisions are reviewed at every end of
reporting period and adjusted according to
its best estimate
- Reversed if no longer probable that an
outflow of economic resources would be
required to settle an obligation
- When discounting is used, carrying
amount of the provision increases every
period to reflect passage of time.
Use of provision
- Provision shall only used for expenditures
provision was purported to be used.
What will happen if an expenditure is charged to a
provision recognized for another purpose?
- Camouflage the impact of two different
events
In effect
- Distort financial performance and constitute
financial fraud.
Future operating losses
- NO provision to be recognized for future
losses.
- An INDICATION for impairment of certain
assets, must perform impairment test
- Only future event, no obligating event (past
event) thus no obligation/liability/provision
is to be recognized
Onerous contract
- ONEROUS contracts are recognized as
provision.
- Measured at the LEAST COST OF
EXITING FROM THE CONTRACT
- Lower amount between cost of fulfilling
the contract and the compensation/penalty
from failure to fulfill the contract
EXAMPLES OF PROVISION (WEDCG)
1. Warranty
2. Environmental contamination
3. Decommissioning or Abandonment cost
4. Court case
5. Guarantee