Share

1          Definitions

A provision is a liability of uncertain timing or amount.

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.

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

A legal obligation is an obligation that derives from:

  1. A contract (through its explicit or implicit terms);
  2. Legislation; or
  3. Other operation of law.

A constructive obligation is an obligation that derives from an entity’s actions

Where:

  1. 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
  2. As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

A contingent liability is:

  1. 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
  2. A present obligation that arises from past events but is not recognised because:
  3. It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
  4. The amount of the obligation cannot be measured 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 entity.

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

A restructuring is a programme that is planned and controlled by management, and materially changes either:

  1. The scope of a business undertaken by an entity; or
  2. The manner in which that business is conducted.

2         Provision Vs. Contingent Liabilities

This Standard distinguishes between:

  1. Provisions – which are recognised as liabilities (assuming that a reliable estimate can be made) because they are present obligations and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations; and
  2. Contingent liabilities – which are not recognised as liabilities because they are either:
    1. Possible obligations, as it has yet to be confirmed whether the entity has a present obligation that could lead to an outflow of resources embodying economic benefits; or
    2. Present obligations that do not meet the recognition criteria in this Standard (because either it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made).

Examples of Provision

  1. Allowance for depreciation
  2. Allowance for irrecoverable debts
  3. Allowance for restructuring
  4. Allowance for warranty claims

Examples of Contingent Liabilities

  1. Lawsuit pending until period end
  2. Environmental restoration cost

Examples of Contingent Assets

  1. Lawsuit pending until period end
  2. Government grant subject to fulfilment of certain conditions to be fulfilled until period end.

3         Recognition Provision, Contingent Liabilities and Contingent Assets

A provision shall be recognised when:

  1. An 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.

If these conditions are not met, no provision shall be recognised.

An entity shall not recognise a contingent liability.

A contingent liability is disclosed, unless the possibility of an outflow of resources embodying economic benefits is remote.

An entity shall not recognise a contingent asset.

Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the entity.

An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain.

3         Calculation of Provisions and Change in Provisions

3.1         Best estimate

The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

% used to estimate a provision is influenced by personal judgement of owner/manager.

Formula:

provision-calculation-formula
click to enlarge

3.2         Changes in provisions

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.

Following 2 scenarios are possible:

  1. Increase in Provision from Previous Year
  2. Decrease in Provision from Previous Year

3.2.1          Increase in Provision from Previous Year

Journal Entries

Expense                                               DR

Allowance/Provision                               CR

(To record expense arising from increase in provision from previous year)

Profit & Loss                                      DR

Expense                                                     CR

(To close expense to profit & loss)

Ledger Entries

Expense

Cross-title Debit Cross-title Credit
Allowance xxx Profit & Loss (bal figure) xxx

 

Allowance for Provision

Cross-title Debit Cross-title Credit
Opening balance xxx
Closing balance xxx Expense (bal figure) xxx

SOCI (Extract)

Operating expense

Increase in Provision Expense   (xxx)

SFP (Extract)

Asset

Non-current/current asset            xxx

Less: Allowance for asset              (xxx)

Provision can be made for current or non-current asset. Provision is not recognized as liability rather provision is offset from relevant asset against which provision is made.

Provision made against one asset should not be offset with other asset. Provision for each asset is shown on a separate line in SOCI.

SOCI (Extract)

Cost of Sales

Allowance for depreciation (plant)                                                           xxx

Operating Expense

Allowance for irrecoverable debt                                                              xxx

Allowance for depreciation (delivery vehicles)                                    xxx

However, provisions can include in relevant category or functions such as cost of sales (plant depreciation), administration expense (allowance for irrecoverable debts) and selling & distribution expense (delivery vehicles depreciation).

3.2.2          Decrease in Provision from Previous Year

Journal Entries

Allowance/Provision                                      DR

Expense                                                                    CR

(To record expense arising from increase in provision from previous year)

Expense                                                              DR

Profit & Loss                                                            CR

(To close expense to profit & loss)

Ledger Entries

Expense

Cross-title Debit Cross-title Credit
Profit & Loss (bal figure) xxx Allowance xxx

 

Allowance for Provision

Cross-title Debit Cross-title Credit
Expense (bal figure) xxx Opening balance xxx
Closing balance xxx

 

SOCI (Extract)

Operating expense

Decrease in Provision Expense  xxx

SFP (Extract)

Asset

Non-current/current asset          xxx

Add: Allowance for asset              xxx

A provision shall be used only for expenditures for which the provision was originally recognised.

Provisions are estimates and are accounted in accordance with IAS 8 Errors, Estimates & Policies.

Related Posts:

Share