9. If the employees have been informed, then an obligation exists and a provision must be made. Rey Co estimate that the damage will cost $400,000 to restore. 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. For example, in the case of an insurance claim where Rey Co can show they have cover. For example, let’s take a fictional company, Rey Co. At the start of the year, Rey Co sets a profit target of $10m for the year ended 31 December 20X8. The IASB is likely to wait until the publication of the Conceptual Framework in 2016 before any … If candidates are able to do this, then provisions can be an area where they can score highly in the FR exam. 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. 7:18. Clearly this is not good for the users of the financial statements, as they would have been manipulated and given a false impression of the performance of the business. IAS 37 – Provisions, contingent liabilities and contingent assets For some ACCA candidates, specific IFRS® standards are more favoured than others. The obligation needs to have arisen from a past event, rather than simply something which may or may not arise in the future. In summary, IAS 37 is a key standard for FR candidates. Here, Rey Co would capitalise the $170m as part of property, plant and equipment. On average, 10% need minor repairs, and 5% need major repairs. Restructuring costs associated with reorganising divisions provide two issues. with a … 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. In this, Rey Co explains that they always replant trees to counter-balance the environmental damage created by their operations. Most candidates are able to spot this in exams, identifying the presence of a potential obligation of this type. Future operating losses do not meet the criteria for a provision, as there is no obligation to make these losses. This should be debited to the statement of profit or loss, with a liability of $9.09m recorded. Here, the provision would be measured at $60k. Careful attention must also be paid to the calculations involved in the recording of a provision, particularly those around long-term provisions and including them at present value. In other words, if there is no past event, then there is no liability and no provision should be recognized. IAS 37 requires a provision be recognised when all of the following apply: an entity has a present obligation (legal or constructive) as a result of a past event. On average, 10% need minor repairs, and 5% need major repairs. The main rule to follow is that if the item is a one-off item, the best estimate will be the most likely outcome. 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. This is because there will not be a one-off payment, so Rey Co should calculate the estimate of all of the likely repairs. As only $150m has been paid, this amount would be credited to cash, with a $20m provision set up. Therefore there cannot be included in the financial statemets. The objective of IAS 37 is to ensure that ap­pro­pri­ate recog­ni­tion criteria and mea­sure­ment bases are applied to pro­vi­sions, con­tin­gent li­a­bil­i­ties and con­tin­gent assets and that suf­fi­cient in­for­ma­tion is disclosed in the notes to the financial state­ments to enable … Rey Co has a consistent history of honouring this policy. A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. 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 are: These criteria will now be examined in further detail to see how they can be applied in practice. Then in the next year, the chief accountant could reverse this provision, by debiting the liability and crediting the profit or loss. the entity has a present obligation. 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. The definition of a provision is key to the standard. Similar to the concept of a contingent liability is the concept of a contingent asset. Instead, a description of the event should be given to the users with an estimate of the potential financial effect. Therefore there cannot be included in the financial statemets. In addition to this, the expected timing of when the event should be resolved should also be included. EPS as a performance measure. The global body for professional accountants, Can't find your location/region listed? The obligation could be a legal or contractual one, arising from a court case or some kind of contractual arrangement. The exception to this is if an entity creates an obligation for future costs due to the construction of a non-current asset. Past experience shows that Rey Co needs to do no repairs on 85% of the goods. Ongoing costs such as the costs of relocating staff should be excluded from the provision and should instead be expensed as they are incurred. Therefore any provision should only include items such as redundancies and closure costs. ACCA BT F1 MA F2 FA F3 LW F4 Eng PM F5 TX F6 UK FR F7 AA F8 FM F9 SBL SBR INT SBR UK AFM P4 APM P5 ATX P6 UK AAA P7 INT AAA P7 UK. So far, all of the items considered in this article have involved the provision being recorded as a liability with the debit being shown as an expense in the statement of profit or loss. The table below shows the treatment for an entity depending on the likelihood of an item happening. 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. (8 marks) (a) (i) Importance of information concerning an… This is where IAS 37 is used to ensure that companies report only those provisions that meet certain criteria. IFRS 10 Consolidated Financial Statements. 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. ACCA CIMA CPD FIA (ACCA) AAT. 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. 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. 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. 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. Rey Co gives a year’s warranty with all goods sold during the year. IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Quiz Free IFRS Quizzes IAS 37 – Provisions, Contingent Liabilities and Contingent Assets Quiz ) , () ) Previous Lesson. Like a contingent liability, a contingent asset is simply disclosed rather than a double entry being recorded. 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