INTERMEDIATE ACCOUNTING 2 MODULE

Chapter 4:
PROVISION – Contingent Liability The expected value or cost of repairs is measured a follows:
20% sales 200,000
5% sales 250,000
Objectives:
Total expected value or cost of repairs 450,000
The learner should be able:
 To understand the nature of a provision.
 To know the conditions for the recognition of a provision.
Illustration 2:
 To know the measurement of a provision.
An entity is a defendant in a patent infringement suit. The lawyers
 To identify measurement considerations for a provision.
believe that there is a 60% chance that the court will not dismiss the
 To know the requirements for the recognition of contingent
case and the entity will incur an outflow of future economic benefits.
asset.
If the court rule against the entity and in favour of the claimant, the
lawyers believe that there is a 30% chance the entity will be
Start of Discussion required to pay damages of P4,000,000 and a 70% chance that the
damages will be P2,000,000.
 PROVISION
A 10% risk adjustment factor to the probabilities of the expected
- It is an existing liability of uncertain timing or uncertain cash flows is considered appropriate to reflect the uncertainties in
amount. The essence of a provision is that there is the cash flow estimate.
uncertainty about the timing or amount of the future
expenditure. Measurement of Provision
- A provision may be the equivalent of an estimated liability or Weighted Probabilities:
a loss contingency that is accrued because it is both probable 30% x P4,000,000 x 60% 720,000
and measurable. 70% x P2,000,000 x 60% 840,000
Expected cash outflow 1,560,000
 Recognition of Provision Risk adjustment factor (10% x 1,560,000) 156,000
a. The entity has a present obligation. Estimated amount of Provision 1,716,000
b. It is probable that an outflow of resources embodying
economic benefits would be required to settle the obligation.
 Other measurement considerations:
c. The amount of the obligation can be measured reliably.
1. Risks and uncertainties
2. Present value of obligation
 Measurement of Provision
3. Future events
- The amount recognized as a provision should be the best
4. Expected disposal of assets
estimate of the expenditure required to settle the present
5. Reimbursements
obligation at the end of reporting period.
6. Changes in provision
- BEST ESTIMATE is the amount that an entity would rationally
7. Use of provision
pay to settle the obligation at the end of reporting period or
8. Future operating losses
to transfer it to a third party at that time.
9. Onerous contract
 Single obligation – most likely outcome
 Examples of Provision:
 Continuous range of possible outcomes – midpoint of the range
a. Warranties
is used.
b. Environmental contamination
 Large population of items – weighting all possible outcomes by
c. Decommissioning or abandonment costs
their associated probabilities.
d. Court case
***Note: The amount of the provision shall be discounted if the e. Guarantee
effect of the time value of money is material.
 RESTRUCTURING
- A program that is planned and controlled by management
Illustration 1: (expected value method) and materially changes either the scope of a business of an
An entity sells goods with a warranty under which customers are entity or the manner in which that business is conducted.
covered for the cost of repairs of any manufacturing defects that
become apparent within 6 months after purchase.  Events that may qualify as restructuring include:
a) Sale or termination of a line of business
If minor defects are detected in all products sold, repair costs would b) Closure of business or business relocation
be about P1,000,000. If major defects are detected in all products
c) Change in management structure
sold, repair costs of P5,000,000 would result.
d) Fundamental reorganization of an entity that has a material
or significant impact on its operations.
The entity’s past experience and future expectations indicate that
75% of the goods sold will have no defects, 20% will have minor
defects and 5% will have major defects.  Provision for Restructuring
INTERMEDIATE ACCOUNTING 2 MODULE
- Recognition of the provision for restructuring is required P25,000,000 and is required by Philippine Law to remove and
because a constructive obligation may arise from the decision dismantle the platform at the end of its useful life of 10 years.
to restructure. The straight line method is used in depreciating the drilling platform.
The entity has estimated that such decommissioning will cost
Two conditions for a constructive obligation for restructuring P5,000,000.
arise:
1. The entity has a detailed formal plan. Based a 12% discount rate, the present value of 1 for 10 years is
2. The entity has raised valid expectation in the minds of those 0.322. Thus the present value of the decommissioning liability is
affected that the entity will carry out the restructuring by P1,610,000.
starting to implement the plan and announcing the main
features to those affected by it. Journal Entries for 2020 and 2021:
2020
 Amount of Restructuring Provisions
Jan. 1 Drilling platform 26,610,00
A restructuring provision shall include only DIRECT
0
EXPENDITURES arising from restructuring and not associated
Cash 25,000,000
with the ongoing activities of the entity. Decommissioning liability 1,160,000

PAS 37 excludes the following expenditures from the Dec. 31 Depreciation 2,661,000
restructuring provision: Accu. Depreciation 2,661,000
a. Cost of retraining or relocating staff.
b. Marketing or advertising program to promote the new Dec. 31 Interest expense 193,200
company image Decommissioning liability 193,200
c. Investment in new system and distribution network.
2021
 CONTINGENT LIABILITY Dec. 31 Depreciation 2,661,000
Accu. Depreciation 2,661,000
- It is a possible obligation that arises from past event and
whose existence will be confirmed only by occurrence or
Dec. 31 Interest expense 216,384
non-occurrence of one or more uncertain future events not Decommissioning liability 216,384
wholly within the control of the entity.
- It is a present obligation that arises from past event but is
not recognized because it is not probable that an outflow of Settlement of Decommissioning Liability
resources will be required to settle an obligation or the aount
-End of Discussion-
of obligation cannot be measured reliably.

 Treatment of Contingent Liability

 CONTINGENT ASSET
- It is a possible asset that arises from past event and whose
existence will be confirmed only by occurrence or non-
occurrence of one or more uncertain future events not wholly
within the control of the entity.
- A contingent asset shall not be recognized because this may
result to recognition of income that may never be realized.
- It is only disclosed when it is probable.

 DECOMMISSIONING LIABILITY
An obligation to dismantle, remove and restore an item of
property, plant and equipment as required by law or contract. It
is also called asset retirement obligation.

Illustration:
An entity extracts natural gas and oil in the Philippine Deep. On
January 1, 2020, the entity constructed a drilling platform for