ACC5036- IAS 37 and IAS 10 Lecture Notes

IAS 37 - Provisions, Contingent Assets, and Contingent Liabilities

Learning Outcomes

  • By the end of the session, students should be able to:

    • Apply the main provisions of IAS 37.

Definitions

  • Provision: Defined as a "liability of uncertain timing or amount" according to IAS 37.

  • Liability: Refers to a present obligation of the entity arising from past events, and settling this obligation is expected to result in an outflow of resources embodying economic benefits.

Recognition of Provisions

  • A provision is recognized when:

    • An entity has a present obligation (legal or constructive) resulting from a past event.

    • It is probable that an outflow of economic benefits will be needed to settle the obligation.

    • A reliable estimate can be made of the obligation’s amount.

Present Obligation

  • Legal Obligation: Comes from contracts, legislation, or law.

  • Constructive Obligation: Arises from the entity’s actions that create a valid expectation in other parties concerning the discharge of certain responsibilities.

Probable Transfer of Economic Benefits

  • A transfer of economic benefits is considered "probable" if there is more than a 50% likelihood of occurrence.

Examples of Provisions

  • Warranty Obligations: Obligations to repair or replace defective products.

  • Legal Obligations: Cleaning up contaminated land or restoring facilities based on legal or constructive promises.

  • Retailer’s Refund Policy: Policies obligating refunds to customers.

  • Onerous Contracts: Contracts where the unavoidable costs of meeting obligations exceed the economic benefits expected.

  • Litigation: Example case of a lawsuit where the company expects to lose.

Accounting Treatment for Provisions

  • Upon recognition, a provision should:

    • Initially be recognized as an expense.

    • Be recorded as a liability on the statement of financial position.

  • Long-term Provisions: Dismantling or environmental provisions should be recorded at present value.

  • Initial Treatment:

    • Dr. Statement of Comprehensive Income (operating expenses)

    • Cr. Non-current liabilities (SFP)

  • Subsequently when settled:

    • Dr. Non-current liabilities

    • Cr. Bank

  • Any adjustments (under/over provision) should be shown in the Statement of Comprehensive Income.

Example 1: Case Study of TK Maxx

  • Scenario: Lawsuit for unjust dismissal with an estimated compensation of £100,000.

  • Requirements:

    • Assess recognition criteria under IAS 37.

    • Determine necessary accounting entries.

Contingent Liabilities

  • Definition:

    • Possible obligation from past events confirmed by future events beyond the entity's control.

    • Present obligation that is not recognized due to low probability (<50%) of economic outflow or inability to measure reliably.

Accounting Treatment for Contingent Liabilities

  • Not recognized in financial statements unless the possibility of an outflow is remote.

  • If material, a disclosure note should include:

    • Nature of the contingent liability.

    • Estimate of its financial effect.

    • Indication of uncertainties regarding amount/timing of outflow.

Example 2: Chester PLC

  • Scenario: Guarantee of a bank loan given by Chester PLC to Wigan Ltd.

  • Reporting Requirements: How to report the guarantee in Chester’s financial statements as of 31 December 2023.

Contingent Assets

  • Definition: Possible asset arising from past events confirmed by uncertain future events beyond the organization's control.

Accounting Treatment for Contingent Assets

  • A contingent asset is not recognized unless virtually certain.

  • If probable (>50%), a note should disclose:

    • Brief description of the contingent asset.

    • Estimate of financial effect.

    • Indication of uncertainties regarding inflow amount/timing.

Example 3: Presley PLC

  • Scenario: Lawsuit against a supplier for faulty goods with a probable ruling in favor of Presley PLC.

  • Reporting Requirements: How this should be reported in Presley’s financial statements as of 31 December 2023.

Recognition Requirements Summary

  • Degree of Probability:

    • Virtually Certain: Make a provision and recognize (receivables).

    • Probable: Make a provision and disclose by note (contingent asset).

    • Possible: Disclose by note (contingent liability).

    • Remote: No disclosure.

IAS 10 - Events After the Reporting Period

Learning Outcomes

  • End of the session, students should be able to apply the main provisions of IAS 10.

Definitions

  • Events After the Reporting Period: Favourable or unfavorable events occurring between reporting date and the approval date of financial statements.

  • Two types of events:

    • Adjusting Events: Provide evidence of conditions existing at the reporting date.

    • Non-adjusting Events: Conditions that arose after the reporting date.

Adjusting Events

  • These events require adjustment in financial statements.

  • Examples:

    • Irrecoverable debt leading to adjustments in receivables.

    • Inventory sale below cost impacting net realizable value.

    • Discovery of errors or fraud affecting financial statements.

Non-adjusting Events

  • Events following the reporting date that do not require adjustments in financial statements.

  • Should be disclosed if significant:

    • Nature of the event and its financial effect.

Example Events

  • Destruction of a plant due to flood after the reporting date.

  • Significant fluctuations in asset prices.

Proposed Dividends

  • Equity dividends proposed before the reporting date and approved after shall not be recognized as liabilities at the reporting date.