Comprehensive Notes on Provisions, Contingent Liabilities, and Contingent Assets

Provisions, Contingent Liabilities, and Contingent Assets

Provisions

• Provisions have measurements and recognition criteria.
• Contingent assets and contingent liabilities are balance sheet items, limited to disclosures.
• Journal entries are made for provisions, unlike contingent items unless it becomes a provision; constantly reassess based on new information.
• Need to produce notes for provisions, similar to PPE notes.

Disclosure Requirements (IAS 37)

• For each class of provision, disclose the carrying amount at the beginning and end of the period.
• Reconciling items: reconcile the opening balance to the closing balance. Not like bank reconciliation!
  • Additional provisions made during the period.
  • Provisions used when a loss or debt happens (debit provision, credit cash).
  • Unused amounts reversed (if the case is won, reverse the provision).
  • Time value of money adjustment (focus on finance cost).
• Comparison of best estimate at $t=0$ purposes are not required.
• Example T-account structure:
  • Opening balance.
  • Additions (increases to the provision).
  • Usage (reduces the provision).
  • Reversals (reduces the provision).
  • Closing balance.
• Provisions can be assessed through carrying amounts, journal entries, or disclosures.

Additional Disclosures

• For every provision, provide:

  • A description of the nature of the obligation (the story behind it).

  • The expected timing of economic benefits (when the money will flow).

  • Important for statement of cash flows.

    • When you debit legal claim and credit provision, no cash is involved.
    • Users need to know when cash outflows related to provisions will occur to time cash flow events.
    • Crucial for valuations performed annually.

  • Disclose if timing is uncertain.

  • Major assumptions:

    • Measurement method (probability-weighted average vs. single most likely amount).
    • Discount rate (how future amounts are adjusted to present value).

Contingent Assets Linkage

• Disclose contingent assets twice. If insured for loss events, the insurance part is a contingent asset.
• Must disclose if insured.
• Give the amount of expected reimbursement.

Disclosure Example

• Provision of $20,000$.
• Major assumptions made.
• Any expected reimbursements.

Real-World Examples

• Extract from financial statements:
  • Reduction in rehabilitation provision, which could be usage or reversal.
  • Reversal of unutilized amounts.
  • Additional provisions and changes to existing ones.
  • Effect of the discount rate (finance cost).
  • Notional interest (time value of money).
• Balance at the end of the year: $18,000,000,000$ in provisions.
• Expected timing of future cash flows:
  • Within 1 year: $1.4$ billion.
  • Within 1-5 years: $5$ billion.
  • Beyond 5 years: $11$ billion.
• Tax consequences to provisions.
• Split between short-term and long-term portions (compliance with IAS 1).
• Companies are required to publicly release information about provisions.

Disclosure Deficiencies

• Lack of description of the nature of the obligation.
• Environment-related provisions should describe the group policy for rehabilitation and estimates of cash flows.

Contingent Liabilities

• Off-balance sheet items; focus is on discussion and disclosure; do not write a journal, focus on the discussion.
• For every class of contingent liability:
  • Describe the nature of the story behind it.
  • Estimate financial effect if practical (cost vs. benefit).
  • Any uncertainties related to the amount or timing of cash flows.
  • Any possible reimbursements.

Example

• ABC Limited is being sued by a customer for an injury in one of its stores.
  • Description of the nature of the story.
  • The opinion is that there is only a possibility that the customer will be successful (less likely than not).
  • Legal process is expected to continue for another year.
  • Only write about reimbursements if you are going to get something.

Contingent Assets

• Give a brief description of the nature of the assets.
• Tell me the financial effects with practical.
• How much you are going to get.
• Reimbursement, another sentence about reimbursements if this whole disclosure is about the reimbursement.

General Disclosure Tips

• If information is not disclosed because it's impractical, say so.
• Users of financial statements need as much information as possible.
• If something is due to the nature of the disputes.

Real-World Example: Coronation vs. SARS

• SARS sued Coronation for understating returns (missing $800,000,000$).
• Ongoing court case.
• Moved from being a contingent liability to a provision.
• Coronation won the case and had to reverse the provision.
• The court sided with the private sector, setting a precedent.
• If interested, look up "Coronation versus the state."