Accounting (Basics) - Lecture 6
Provisions and contingencies


Contents
nInitial recognition
nInitial and subsequent measurement
nContingent assets and liabilities
nDisclosures
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Initial recognition
nAn entity shall recognize a provision only when :
a)the entity has an obligation at the reporting date as a result of a past event;
b)it is probable (i.e. more likely than not) that the entity will be required to transfer economic
benefits in settlement; and
c)the amount of the obligation can be estimated reliably.
nThe entity shall recognize the provision as a liability in the statement of financial position and
shall recognize the amount of the provision as an expense, unless another section of these IFRS
requires the cost to be recognized as part of the cost of an asset such as inventories or property,
plant and equipment.
n
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Initial recognition
nThe condition of obligation at the reporting date as a result of a past event means that the
entity has no realistic alternative to settling the obligation. This can happen when the entity has
a legal obligation that can be enforced by law or when the entity has a constructive obligation
because the past event (which may be an action of the entity) has created valid expectations in
other parties that the entity will discharge the obligation. Obligations that will arise from the
entity’s future actions (i.e. the future conduct of its business) do not satisfy such condition, no
matter how likely they are to occur and even if they are contractual. To illustrate, because of
commercial pressures or legal requirements, an entity may intend or need to carry out expenditure
to operate in a particular way in the future (for example, by fitting smoke filters in a particular
type of factory). Because the entity can avoid the future expenditure by its future actions, for
example by changing its method of operation or selling the factory, it has no present obligation
for that future expenditure and no provision is recognized.
n
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Initial and subsequent measurement
nAn entity shall measure a provision at the best estimate of the amount required to settle the
obligation at the reporting date. The best estimate is the amount an entity would rationally pay to
settle the obligation at the end of the reporting period or to transfer it to a third party at that
time.
nWhen the provision involves a large population of items, the estimate of the amount reflects the
weighting of all possible outcomes by their associated probabilities. Where there is a continuous
range of possible outcomes, and each point in that range is as likely as any other, the mid-point
of the range is used.
nWhen the provision arises from a single obligation, the individual most likely outcome may be the
best estimate of the amount required to settle the obligation.
nWhen the effect of the time value of money is material, the amount of a provision shall be the
present value of the amount expected to be required to settle the obligation. The discount rate
shall be a pre-tax rate that reflects current market assessments of the time value of
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Initial and subsequent measurement
nmoney. The risks specific to the liability should be reflected either in the discount rate or in
the estimation of the amounts required to settle the obligation, but not both.
nAn entity shall exclude gains from the expected disposal of assets from the measurement of a
provision.
nWhen some or all of the amount required to settle a provision may be reimbursed by another party,
the entity shall recognize the reimbursement as a separate asset only when it is virtually certain
that the entity will receive the reimbursement on settlement of the obligation. The amount
recognized for the reimbursement shall not exceed the amount of the provision. The reimbursement
receivable shall be presented in the statement of financial position as an asset and shall not be
offset against the provision. In the statement of comprehensive income, the entity may offset any
reimbursement from another party against the expense relating to the provision.
n
n
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Initial and subsequent measurement
nAt subsequent measurement an entity shall charge against a provision only those expenditures for
which the provision was originally recognized. An entity shall review provisions at each reporting
date and adjust them to reflect the current best estimate of the amount that would be required to
settle the obligation at that reporting date. Any adjustments to the amounts previously recognized
shall be recognized in profit or loss unless the provision was originally recognized as part of the
cost of an asset. When a provision is measured at the present value of the amount expected to be
required to settle the obligation, the unwinding of the discount shall be recognized as a finance
cost in profit or loss in the period it arises.
n
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Contingent assets and liabilities
nAn entity shall not recognize a contingent asset as an asset. Disclosure of a contingent asset is
required when an inflow of economic benefits is probable. However, when the flow of future economic
benefits to the entity is virtually certain, then the related asset is not a contingent asset, and
its recognition is appropriate.
nA contingent liability is either a possible but uncertain obligation or a present obligation that
is not recognized because it fails to meet one or both initial recognition criteria (b) and (c)
stated earlier. An entity shall not recognize a contingent liability as a liability, except for
provisions for contingent liabilities of an acquire in a business combination. Disclosure of a
contingent liability is required unless the possibility of an outflow of resources is remote. When
an entity is jointly and severally liable for an obligation, the part of the obligation that is
expected to be met by other parties is treated as a contingent liability.
n
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Disclosures
nFor each class of provision, an entity shall disclose:
a)a reconciliation showing:
i.the carrying amount at the beginning and end of the period;
ii.additions during the period, including adjustments that result from changes in measuring the
discounted amount;
iii.amounts charged against the provision during the period; and
iv.unused amounts reversed during the period.
b)a brief description of the nature of the obligation and the expected amount and timing of any
resulting payments.
c)an indication of the uncertainties about the amount or timing of those outflows.
d)the amount of any expected reimbursement, stating the amount of any asset that has been
recognized for that expected reimbursement.
nComparative information for prior periods is not required.
n
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Disclosures
nUnless the possibility of any outflow of resources in settlement is remote, an entity shall
disclose, for each class of contingent liability at the reporting date, a brief description of the
nature of the contingent liability and, when practicable:
a)an estimate of its financial effect;
b)an indication of the uncertainties relating to the amount or timing of any outflow; and
c)the possibility of any reimbursement.
nIf an inflow of economic benefits is probable, but not virtually certain, an entity shall disclose
a description of the nature of the contingent assets at the end of the reporting period, and, when
practicable without undue cost or effort, an estimate of their financial effect. If it is
impracticable to make this disclosure, that fact shall be stated.
n
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