PROVISION
Definition
-is an existing liability of uncertain
timing or uncertain amount.
RECOGNITION
PAS 37, paragraph 14, provides that a provision shall be recognized
as a liability in the financial statements under the following
conditions:
a. The entity has a present obligation, legal or constructive, as a
result of a past event.
b. It is probable that an outflow of resources embodying economic
benefits would be required to settle the obligation.
c. The amount of the obligation can be measured reliably.
Present Obligation
• Legal Obligation - is an obligation arising from contract,
legislation or other operation of law.
• Constructive Obligation - exists when the entity from an
established pattern of practice or stated policy has
created a valid expection that it will accept certain
responsibilities.
Past Event
An obligating event is an event that creates a legal or
constructive obligation because the entity has no realistic
alternative but to settle the obligation created by the event.
This is the case where:
a. The settlement of the obligation can be enforced by law.
b. The event creates valid expectations on the part of other
parties that the entity will discharge the obligation, as in the
case of a constructive obligation.
Probable outflow
What does “probable” mean?
“The event is more likely than not to occur”
• Probable - > 50% likely or substantially more
• Possible - < 50% or less likely to occur
• Remote - < 10% or less likely to occur or very slight occurence
• Certain - 100%
• Impossible - 0%
Reliable estimate
When no reliable estimate can be made, no liability is recognized.
MEASUREMENT
Best estimate - the amount that an entity would rationally pay to
settle the obligation at the end of reporting period.
• If single obligation is measured - most likely outcome
adjusted for the effect of other possible outcomes
• If range of possible outcomes - the midpoint of the range is
used assuming each point in that range is as likely as any
other.
• If large population - “expected value”
Illustration - expected value method
An entity sells goods with a warranty under which customers are covered for the cost
of repairs of any manufacturing defects that become apparent within 6 months after
purchase.
If minor defects are detected in all products sold, repair costs would be about
P1,000,000.
If major defects are detected in all products sold, repair costs of P5,000,000 would
result.
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.
The expected value or cost of repairs is measured by weighting all possible outcomes
by their associated probabilities.
Illustration - expected value method
An entity is a defendant in a patent infringement suit The lawyers believe that there is a
60% chance that the court will not dismiss the case and the entity will incur an outnorw
of future economic benefits.
If the court rules against the entity and in favor of the claimant, the lawyers believe that
there is a 30% chance the entity will be required to pay damages of P4,000,000 and
70% chance that the damages will be P2,000,000.
A 10% risk adjustment factor to the probabilities of the expected cash flows is
considered appropriate to reflect the uncertainties in the cash flow estimate.
Other measurement considerations
1. Risks and uncertainties
2. Present value of obligation
3. Future events
4. Expected disposal of assets
5. Reimbursements
6. Changes in provision
7. Use of provision
8. Future operating losses
9. Onerous contract
examples:
1. Warranties
2. Environmental Contamination
3. Decommissioning / Abandonement Cost
4. Court Case
5. Guarantee (loan)
Restructuring (PAS 37, par. 10)
- Planned and controlled by management.
Material program that changes:
• Scope of business, or
• Manner in which business is conducted.
• Sale or termination of a line of business.
Events • Closure or relocation of business
that may locations/headquarters.
qualify as • Change in management structure (e.g.,
eliminating a layer, making units
restructuring autonomous).
include: • Fundamental reorganization with material
impact.
Provision for
Restructuring
Constructive obligation exists when:
1. The entity has a detailed formal plan for the
restructuring which includes:
• Business affected
• Location(s)
• Employees to be terminated
• Implementation date
• Estimated expenditures
Provision for
Restructuring
2. Valid Expectation raised by:
• Announcing plan to affected parties
• Starting implementation
Amount of restructuring provision
Includes only direct expenditures arising from restructuring:
• Costs necessary and directly linked to restructuring.
• Not related to ongoing activities.
Example: Salaries and benefits of employees after closure of
operations.
Amount of restructuring provision
Expenditures Excluded (PAS 37, par. 81)
The following are not part of restructuring provision since they
relate to future business conduct:
• Cost of retraining or relocating continuing staff.
• Marketing or advertising programs for new company image.
• Investments in new systems and distribution networks.
Problem 1:
During the current year, Probiotics Company is the defendant in a breach of patent
lawsuit. The lawyers believe there is an 80% chance that the court will not dismiss the
case and the entity will incur outflow of benefits.
If the court rules in favor of the claimant, the lawyers believe that there is a 60% chance
that the entity will be required to pay damages of P2,000,000 and a 40% chance that the
entity will be required to pay damages of P 1,000,000. Other amounts of damages are
unlikely.
The court is expected to rule in late December next year. There is no indication that the
claimant will settle out of court.
A 7% risk adjustment factor to the cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates.
An appropriate discount rate is 10% per year. The present value of 1 at 10% for one
period is 0.91.
What amount should be reported as provision at current year-end?
Problem 2:
During the current year, Manfred Company guaranteed a supplier's P500.000 loan from a
bank. In October, the entity was notified that for bankruptcy the supplier had defaulted
on the loan and filed for protection. Counsel believed that the entity would probably
have to pay P250,000 under the guarantee.
As a result of supplier’s bankruptcy, the entity entered into a contact in December to
retool its machines so that the entity could accept parts from other suppliers. Retooling
costs are estimated to be P300.000.
What amount should be reported as liability at current year-end?
Answer: P250,000
The guarantee should be accrued as a provision because the loss is probable
and the amount can be reasonably estimated.
CONTINGENT
LIABILITY
Contingent Liability (PAS 37, par. 10)
Defined in two ways:
1. A possible obligation from past event, confirmed only by uncertain future
events beyond the entity’s control.
2. A present obligation from past event, but:
• Not probable that outflow of resources will be required, or
• Amount cannot be measured reliably.
*not recognized because it is not probable
Treatment of contigent liability
LIABILITY ASSET
Certain (100%) Recognized Recognized
Virtually Certain (>90%) Recognized Recognized
Probable ( >50%) Recognized Disclosed
Possible ( <50%) Disclosed Ignored
Remote (10% or less) Ignored Ignored
Impossible (0%) Ignored Ignored
Disclosure Requirements:
• Contingent Liability
a. Brief description of the nature of the contingent liability
b. An estimate of its financial effects
c. An indication of the uncertainties that exist
d. Possibility of any reimbursement
• Contingent Asset
a. Brief description of the nature of the contingent asset
b. An estimate of its financial effects
Problem 3:
Toyriginals Co. provided the following facts regarding pending litigation at year end:
• The entity is defending against a first lawsuit and believed there is a 31% chance it will lose in court.
The entity estimated that damages will be P1,000,000.
• The entity is defending against a second lawsuit for which management believed it is virtually
certain to lose in court. If it loses the lawsuit, management estimated that damages will fall
somewhere in the range of P3,000,000 to P5,000,000 with each amount in that range equally likely
to occur.
• The entity is defending against a third lawsuit but the probable and relevant loss will only occur far
into the future. The present values of the endpoints of the range are P1,500,000 and P2,500,000,
The management believed the effects of time value of money on these amounts are material.
• The entity is defending against a fourth lawsuit and believed there is only a 25% chance it will lose
in court. If the entity loses, management believed damages will fall somewhere in the range of
P3,000,000 to P4,000,000 with each amount in the range equally likely to occur.
What amount should be reported as accrued liability at year-end?
DECOMMISSIONING
LIABILITY
Definition
A decommissioning liability is an obligation to
dismantle, remove and restore an item of
property, plant and equipment as required by law
or contract. A decommissioning liability is also
called asset retirement obligation.
Cost of PPE
1. Purchase price
2. Directly Attributable cost
3. Estimated Cost of Dismantling*
*when the obligation arises at the time of acquisition or installation of the asset
Illustration
On January 1, 2021, an entity engaged in extracting natural gas and oil constructed a
drilling platform for P25,000,000 and is required by Philippine law to remove and
dismantle the platform at the end of its useful life of 10 years. The straight line method
is used in depreciating the drilling platform.
The entity had estimated that such decommissioning will cost P5,000,000. Based on a
12% discount rate, the present value of 1 for 10 years is 0.322.
Thus, the present value of the decommissioning liability is P5,000,000 times 0.322 or
P1,610,000.
The decommissioning liability is initially recognized at present value and included in the
cost of the related asset.
What is the journal entries for 2021 and 2022?
Settlement of decommissioning liability
• On December 31, 2030, after 10 years, the entity contracted with another entity to
dismantle and remove the drilling platform for P5,500,000.
The journal entry to record the settlement of the decommissioning liability is:
Decommissioning liability 5,000,000
Loss on settlement 500,000
Cash 5,500,000
What is the journal entry to derecognize the carrying amount of the drilling platform on
December 31, 2030?
Change in decommission liability (IFRIC 1)
Accounting Treatment
1. Decrease in Liability
• Deducted from the cost of the related asset.
• If decrease exceeds the asset’s carrying amount → excess
recognized in profit or loss.
2. Increase in Liability
• Added to the cost of the asset.
• Must assess if the asset’s carrying amount is still recoverable.
• If not recoverable → perform impairment test
THANK YOU!
Pepared by: Rechelle Valer, CPA
