PROVISIONS,
CONTINGENT
LIABILITIES AND
CONTINGENT ASSETS
Kiara Cerisse C. Singian, CPA
Learning Objectives
▪ State the recognition criteria for provisions.
▪ Differentiate the accounting requirements of a provision, a contingent liability and a
contingent asset.
▪ Describe the available measurement bases for a provision.
▪ Account for provisions.
Provisions
▪ A provision is a liability of uncertain timing or amount.
▪ Provisions differ from other liabilities because of the uncertainty about the timing or
amount of expenditure required in settlement. Unlike for other liabilities, provisions
must be estimated. Although, some other liabilities are also estimated, their
uncertainty is generally much less than for provisions.
▪ Other liabilities, such as accruals, are reported as part of “Trade and other
payables” whereas provisions are reported separately.
Provision vs. Contingent liability
Provision
Contingent liability
▪ Present obligation
▪ Possible obligation
▪ Probable and measured reliably
▪ Present obligation but not probable or
Present obligation but not measured
▪ Recognized (accrued in the statement of
financial position)
reliably
▪ Not recognized (not accrued in the
statement of financial position)
Recognition of provisions
▪ A provision is recognized when all of the following conditions are met:
1.
The entity has a present obligation (legal or constructive) as a result of a past
event;
2.
It is probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; and
3.
A reliable estimate can be made of the amount of the obligation.
Range of outcome
Present obligation is
Recognize or accrue a
outflow of economic
both probable and reliably
estimable.
Provide appropriate
The future event is likely to
As a rule of thumb,
means more than 50%
Present obligation is
Disclose only a contingent
liability.
Present obligation is remote
Do nothing.
Do not recognize or accrue
liability.
The future event is less
occur. The occurrence is
less.
The future event is least
occur or the chance of the
event occurring is very
occurrence is 10% or less.
Measurement
Nature of the outflow
Measurement basis
1. General rule
➢ Best estimate
2. Involves a large population of items
➢ Expected value (Probability Weighted
3. Each possible outcome in a range is as
any other
➢ Mid-point
Present value
▪ Where the effect of the time value of money is material, the amount of a provision
shall be the present value of the expenditures expected to be required to settle the
obligation.
Expected disposal of assets
▪ Gains from the expected disposal of assets shall not be taken into account in
measuring a provision. Gains shall be recognized only when the assets are actually
disposed of.
Reimbursements
▪ Where some or all of the expenditure required in settling a provision is expected to
be reimbursed by another party, the reimbursement is recognized only when it is
virtually certain that reimbursement will be received if the entity settles the
obligation.
▪ The reimbursement shall be treated as a separate asset.
▪ In the statement of profit or loss and other comprehensive income, the expense
relating to a provision may be presented net of the amount recognized for a
reimbursement.
Changes in provisions
▪ Provisions shall be reviewed at the end ▪ If it is no longer probable that an outflow
of each reporting period and adjusted to of resources embodying economic
reflect the current best estimate.
benefits will be required to settle the
obligation, the provision shall be
reversed.
Product warranties and guarantees
▪ If a customer has the option to purchase ▪ If a customer does not have the option
a warranty separately (for example,
to purchase a warranty separately, the
because the warranty is priced or
warranty is accounted for in accordance
negotiated separately), the warranty is
with PAS 37 Provisions, Contingent
accounted for in accordance with PFRS
Liabilities and Contingent Assets unless
15 Revenue from Contracts with
the promised warranty provides the
Customers.
customer with a service in addition to
the assurance that the product complies
with agreed-upon specifications.
Liability for premiums
▪ A customer option to acquire additional ▪ A customer option that does not provide
goods or services for free or at a
the customer with a material right is not
discount is accounted for under PFRS 15 accounted for under PFRS 15; and
if the option provides the customer a
therefore, accounted for in accordance
material right that the customer would
with PAS 37.
not receive without entering into that
contract.
Guarantee for indebtedness of others
▪ A provision for the guarantee for indebtedness of others is recognized when it
becomes probable that the entity will be held liable for the guarantee, such as when
the original debtor defaults on the loan.
Contingent assets
Contingent asset is probable Contingent asset is possible
Contingent asset is remote
Disclose only a contingent
Do not recognize or accrue.
Do nothing.
Do nothing.
APPLICATION OF CONCEPTS
Application of Concepts
Fact Pattern:
Transcribe Co. is engaged in transport services. A lawsuit was filed against Transcribe
Co. regarding a road accident that occurred late in December 20x1. Transcribe Co.'s
legal counsel believes that Transcribe Co. will probably lose the case and pay
damages. Sufficient data is available to make a reliable estimate of the damages.
Should Transcribe Co, accrue a provision on December 31, 20x1? Provide a brief
explanation of your answer.
Application of Concepts
1. Answer: Yes. All the elements of the recognition criteria are met:
a. Present obligation arising from past event – an accident already happened, and a lawsuit was filed
against the entity.
b. Probable outflow – the entity expects to lose the case and pay damages.
c. Reliable estimate – the problem states that “Sufficient data is available to make a reliable
estimate of the damages.”
Application of Concepts
Fact Pattern:
Transcribe Co. is engaged in transport services. A lawsuit was filed against Transcribe
Co. regarding a road accident that occurred late in December 20x1. Transcribe Co.'s
legal counsel believes that Transcribe Co. will probably lose the case and pay
damages. Sufficient data is available to make a reliable estimate of the damages.
Transcribe Co.'s best estimate of the payment for damages is P4M. What is the entry
to accrue the provision?
Application of Concepts
Dec.
31,
20x1
Probable loss on lawsuit
Estimated liability on pending lawsuit
4,000,000
4,000,000
Application of Concepts
Fact Pattern:
Transcribe Co. is engaged in transport services. A lawsuit was filed against Transcribe
Co. regarding a road accident that occurred late in December 20x1. Transcribe Co.'s
legal counsel believes that Transcribe Co. will probably lose the case and pay
damages. Sufficient data is available to make a reliable estimate of the damages.
Transcribe Co.'s legal counsel believes that there is a 20% chance that Transcribe Co.
will win the case. If, however, Transcribe Co. will lose, there is a 30% chance that it will
pay damages of P9M (the amount sought by the plaintiff) and a 70% chance that it will
pay damages of P4M (the amount awarded to the plaintiff in a similar case that was
recently concluded). Other outcomes, are unlikely. A 4% risk adjustment factor is
considered appropriate to reflect the uncertainties in the cash flow estimates. The
court decision is expected to be finalized in December 20x2. The appropriate discount
rate is 12%. What is the entry to accrue the provision?
Application of Concepts
Dec.
31,
20x1
Probable loss on lawsuit
Estimated liability on pending lawsuit
4,085,714
4,085,714
Application of Concepts
Fact Pattern:
Transcribe Co. is engaged in transport services. A lawsuit was filed against Transcribe
Co. regarding a road accident that occurred late in December 20x1. Transcribe Co.'s
legal counsel believes that Transcribe Co. will probably lose the case and pay
damages. Sufficient data is available to make a reliable estimate of the damages.
Transcribe Co.'s legal counsel believes that Transcribe Co. will probably pay damages
of not less than P2M but not more than P7M. The probability of any amount within the
range is as likely as any other amount within that range. The plaintiff is offering an
out-of-court settlement of P6.2M but Transcribe Co. does not agree. What is the entry
to accrue the provision?
Application of Concepts
Dec.
31,
20x1
Probable loss on lawsuit [(2M + 7M) / 2]
Estimated liability on pending lawsuit
4,500,000
4,500,000
Application of Concepts
On December 31, 20x1, Aural Co. accrues a provision of P5M for an expected loss on
a pending labor case. On December 31, 20x2, Aural Co. reviews its estimate and
concludes that an estimate of P4.8M is more appropriate. The case is settled in 20x3
and Aural Co. pays damages of P5.1M. Provide the journal entries in 20x1 to 20x3.
Application of Concepts
Dec.
31,
20x1
Probable loss on lawsuit
Estimated liability on pending lawsuit
5,000,000
Dec.
31,
20x2
Estimated liability on pending lawsuit
Gain on revision of estimate
200,000
20x3
Estimated liability on pending lawsuit
Loss on lawsuit
Cash
4,800,000
300,000
5,000,000
200,000
5,100,000
Application of Concepts
Ear Co. provides 5-year warranty for its products. Warranty costs, related to sales, are
estimated at 2% in the year of sale and 4% in the subsequent years. The warranty
obligation has a balance of P160,000 as of January 1, 20x1. Information for 20x1 and
20x2 is as follows:
Year
Sales
Actual warranty costs
20x1
P10,000,000
P400,000
20x2
12,000,000
500,000
Requirements:
a.
Provide the journal entries in 20x1 and 20x2 to record the actual warranty costs
and the provisions for warranty obligation.
b.
Compute for the balance of the warranty obligation on December 31, 20x2.
Application of Concepts
20x1
Warranty expense (10M x 6% (a))
Warranty obligation
600,000
Warranty obligation
Cash (or other asset account)
400,000
to record the provision for warranty costs
to record the actual warranty costs
(a)
600,000
400,000
2% + 4% = 6%
20x2
Warranty expense (12M x 6%)
Warranty obligation
720,000
Warranty obligation
Cash (or other asset account)
500,000
to record the provision for warranty costs
to record the actual warranty costs
720,000
500,000
Application of Concepts
Application of Concepts
Listen Co. has an ongoing sales promotion. For every five bottle crowns returned to Listen
Co., customers receive a T-shirt. The unit cost of the T-shirt is P100. Listen Co. estimates
that 80% of sales will be redeemed. Listen Co.'s premium liability as of December 31, 20x0
is P720,000. Additional information is as follows:
Units
Sales in 20x1
500,000
Sales in 20x2
900,000
T-shirts distributed in 20x1
60,000
T-shirts distributed in 20x2
147,000
Requirements:
a.
Provide the journal entries in 20x1 and 20x2 to record the actual costs of premiums
distributed and the provisions for premium liability.
b.
Compute for the balance of the premium liability on December 31, 20x2.
Application of Concepts
20x1
Premium expense [(500K x 80% ÷ 5) x ₱100 )]
Estimated liability for premiums
8,000,000
Estimated liability for premiums
(60,000 T-shirts x ₱100)
Premiums
6,000,000
to record the provision for premiums
8,000,000
6,000,000
to record the actual premiums distributed
20x2
Premium expense [(900,000 x 80% ÷ 5) x ₱100]
Estimated liability for premiums
14,400,000
Estimated liability for premiums
(147,600 T-shirts x ₱100)
Premiums
14,760,000
to record the provision for premiums
to record the actual premiums distributed
14,400,000
14,760,000
Application of Concepts
Application of Concepts
On January 1, 20x1, Loving Co. guaranteed a bank loan of Shameless Co. amounting
to P1,000,000. On December 31. 20x1, Shameless Co. defaulted, and it has become
probable that Loving Co. will be held liable to the bank for P1,000,000. What are the
journal entries in Loving Co.'s books in 20x1?
Application of Concepts
Jan. 1, No entry
20x1
Dec.
31,
20x1
Probable loss on guarantee
Estimated liability for guarantee
1,000,000
1,000,000
QUESTIONS?