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FINANCIAL REPORTING

IAS 37: PROVISIONS, CONTINGENT

LIABILITIES AND CONTINGENT ASSETS

Mr.fidelis: MFI, BAF-PS, SITI, CPA (T)

Coverage
1.OBJECTIVE OF IAS 37 2

1.PROVISIONS
 Definition of a provision
 A difference between a provision and other liabilities
 Recognition of a provision
 Measurement of a provision
 Specific types of a provision

2.CONTINGENT LIABILITY
 Definition of a contingent liability
 Recognition of a contingent liability

3.CONTINGENT ASSET
 Definition of a contingent asset
 Recognition of a contingent asset
1. The Objective of IAS 37

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 IAS 37 Provisions, Contingent Liabilities and Contingent
Asset aims at ensuring that appropriate recognition criteria
and measurement basis are applied to provisions, contingent
liabilities and contingent assets and that sufficient information
is disclosed in the notes to the financial statements to enable
users to understand their nature, timing and amount.
 The key aim of this standard is to ensure that provisions are
made only when there are valid grounds for them.
 PROVISION 4
DEFINITION OF A PROVISION
The IAS 37 defines provision as a liability of uncertain
timing or amount.
The only difference between a provision and other liabilities is the element of
uncertainty with regard to timing or amount of future expenditure.
Liability present obligation of the entity as a result of past event the settlement of which
is expected to result into an outflow of future economic benefit from the entity.
Accounting treatment
Provision for items of PNL
DR :PNL xxxx
CR :Provision(Liability) xxxx
Provision for items of SOFP
DR :PPE xxxx
CR : Provision(Liability) xxxx
The only difference between a provision and other liabilities like trade
creditors and accruals under IAS 37 is the element of uncertainty with
regard to timing or amount of future expenditure.
 RECOGNITION OF A PROVISION
IAS 37 states that a provision should be recognized as a liability in 5
the financial statement when:
1. An entity has a present obligation (legal or constructive) as a result of
past events
2. It is probable that an outflow of resources embodying economic
benefits will be required to settle the obligation.
3. A reliable estimate can be made of the amount
Legal obligation is an obligation that is derived either from a
contract, legislation or operations of the law.
Constructive obligation is an obligation that is derived from the entity’s
operations as:
a) The entity has indicated to other parties that it will accept a certain
responsibilities by an established pattern of past practice, published
policies or a sufficiently specific current statement.
b) As a result, the entity has created a valid expectation on the part of those
other parties that it will discharge those responsibilities.
A transfer of resources embodying economic benefits is regarded as
probable if the event is more likely than not to occur. This appears to
indicate a probability of more than 50%. However a standard makes it clear
that where there is a number of similar obligations the probability should be
based on considering the population as a whole rather than one single item
 MEASUREMENT OF PROVISIONS
1. Best Estimate of Expenditure: Recognize the provision based on
the most accurate estimate of the cost to settle or transfer the
obligation.
2. Time Value of Money: Discount the provision to its present value if
the time value of money significantly affects the amount.
3. Future Events: Consider only those future events that are likely and
have objective evidence of affecting the obligation.
4. Expected Reimbursements: Recognize reimbursements only
when their receipt is virtually certain, treating them as a separate
asset.
5. Risks and Uncertainties: Take into account risks and uncertainties
without excessively overestimating or underestimating the provision.
6. Changes in Provisions: Regularly reassess and adjust provisions
to reflect the most current and accurate estimates
 TYPES OF PROVISIONS
Warranties: Obligations to repair/replace faulty goods;
recognized if claims are probable based on past experience.
Repairs and Maintenance: Only recognized if a legal or
constructive obligation exists (e.g., due to a contract).
Environmental Contamination: Recognized if there is a legal
obligation or a policy that creates a valid expectation.
Self-Insurance: Not recognized unless an event (e.g.,
damage) has occurred; no provision for future incidents.
Decommissioning or Abandonment Costs: Recognized from the
start of operations due to a legal obligation to restore sites (Should
be capitalized).
Onerous Contracts: Recognized when the cost of fulfilling a
contract exceeds expected benefits.
Future Operating Losses: Not recognized as they do not
meet the definition of a liability
 RESTRUCTURING
A programme that is planned and controlled by management
and materially changes either:-
a) The scope of the business undertaken by an entity; or
b) The manner in which the business is conducted
Examples Includes
a) The sale or termination of a line of business;
b) The closure of business locations in a country or region or
the relocation of business activities from one country region to
another;
c) Changes in the management structure, for example the
elimination of a layer of management and
d) Fundamental re-organizations that have material effect on
the nature and focus of the entities operations
Recognition Criteria Includes
i. An entity must have a detailed formal plan for
restructuring.
ii. It must have raised a valid expectation in those
affected that it will carry out the restructuring by starting
to implement that plan or announcing its main features to
those affected by it.

Recognize the direct Restructuring cost only, i.e. do not

include
 Retraining or relocating continuing staff;
 Marketing;
 Investment in new systems and distribution networks
 CONTINGENT LIABILITY
A contingent liability can be defined as follows:
a) A possible obligation that arises from past events and whose
existence will be confirmed only by the occurrence or non-
occurrence of certain future events not wholly within the control
of the entity; or
b) A present obligation that arises from past events but is not
recognized because:
i. It is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation; or
ii. The amount of obligation can not be measured with sufficient
reliability
The contingent liabilities should not be recognized in the financial
statements but they should be disclosed. The required disclosures
may be:-
a. A brief description on the nature of the contingent liability
b. An estimate of its financial effect
c. A indication of the uncertainties that exist
d. The possibility of any re-imbursement
 CONTIGENT ASSETS
 A contingent asset refers to a possible asset that
arises from past events and whose existence will be
confirmed by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control
of the entity.
 A contingent asset must not be recognized. Only
when the realization of the related economic benefit is
virtually certain should recognition take place. At that
point the asset is no longer a contingent asset.
 EXAMPLE 1
Mzee Ngogwe Co offers a warranty covering the customers for cost of
repairs on the sale of all its goods for one year after the purchase date.
Past experience suggest that 90% of the goods will have major defects,
4% will have no defects and 6% will have minor defects. If major defects
were detected then the cost of repairs will be TAS 500,000. if minor
defects were detected then the cost of repairs would be TAS 40,000.
Required: should a provision be recognized? If yes why and at what
amount? If no why?
 EXAMPLE 2
Kidoti Co. has a contract with its supplier. The contract
is for the future purchase of 2000 litres of a chemical
which is to be used in the production of laundry
detergent. Bizo Co. has sold its laundry detergent
business but has been unable to assign the contract .
The contract price is TAS 150 per litre. At 30th sept.
2024 the spot price is TAS 90 per litre. If Bizo cancels
the contract a cancellation fee of TAS 135000 is
payable.
How should the contract be accounted for in the FS of
Kidoti at 30th June 2024
 EXAMPLE 3
On the 31st may 2019 a decision was made by the board to
close a division. On the 20th June 2019 a detailed plan was
agreed and redundancy notices issued to all staffs of the
affected division at a cost of TAS 75,000. the division was
closed on the 30th sept. 2019.
Should a provision be made at the accounting year end which
is 31st July 2019?
 EXAMPLE 4
During 2024 Bamai Co. gives a guarantee of certain borrowings of
Nyirenda Co., whose financial condition at that time is sound. During
2025, the financial condition of Nyirenda Co. deteriorates and at 30 th
June 2025 Nyirenda Co. Files for protection from it’s creditors.
Required:
i. What accounting treatment is required at 31st Dec 2024?
ii. What accounting treatment is required at 31st Dec 2025?

Answer I
There is present obligation as a result of past event. The obligating event is
giving the guarantee, which gives rise to a legal obligation. However at 31st
Dec 2019 no transfer of resources is probable in settlement of the obligation.
Therefore no provision should be recognized. The guarantee is disclosed as a
contingent liability unless the probability of any transfer is regarded as
remote.
 TUTORIAL QUESTIONS
QUESTION 1 1
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A company sells goods with a warranty for the cost of repairs
required in the first 2 months after purchase.
Past experience suggests:
88% of the goods sold will have no defects
7% will have minor defects
5% will have major defects
i.If
minor defects were detected in all product sold, the cost of
repair will be TZS 24,000.
ii.If
major defects were detected in all product sold, the cost would
be TZS 200,000.
Required
What amount of provision should be made?
 Question 2
A company start using an oil rig at a cost as follows
Construction TZS 200,000,000.00
Installation TZS 100,000,000.00
The oil starts pumping at the year start. At this point the
company sign a licence with the government agreeing to
dismantle the rig when the oil runs out which is estimated to be
20 Years. The cost of dismantling the rig is estimated at TZS
120,000,000.00 and the discount rate is 10%

Required
Discus the financial statement effects for the current year
 Question 3

You are the audit manager in Ruto, Certified Public Accountant in Public Practice. During the audit of Rambo lid
you are approached by the financial accountant who is having difficulty understanding on how to account for
several matters. He has asked you to provide him with some notes in respect of the following items so that he
can discuss the m with the finance director. The company year ends on 31s march and the Annual General
Meeting is held in January each year.

i.At31st march 2013 a provision of TZS. 100m was made for the cost of a court case against the company.
During April 2013 an 'out of court' settlement of TZS. 125m was agreed. Legal fees of TZS. 10m not provided
for were incurred.

ii.On
3rd march 2013 the finance director and production director signed the contract for the purchase of new
machinery costing TZS. 1000m to be delivered and paid for on 30m June2013. The machinery will be put into
operation immediately upon delivery.

iii.DuringMarch 2013 Rambo began legal proceedings against another company whose website was using a
domain name registered by Rambo. On 28* march 2013 Rambo's solicitors filed a claim for damages
amounting TZS100m. The case is expected to take severai months to settle and the outcome is uncertain at
this stage. Legal fees of TZS.20m are expected. No provision has been made for those legal fees.

iv.On 30th April 2013 the Board of directors proposed a final dividend of TZS. 1000 per ordinary share be paid
for the year ended 31st march 2013, subject to approval at the shareholders annual general meeting.

v.Atthe shareholders annual general meeting the board of directors will announce the* amalgamation of the
two sites on 31st October 2013. This will result in redundancy cost of TZS.250m and annual savings of
TZS.500m.

vi.Duringthe year: Rambo sold goods with a warranty under which customers are covered for the cost of repairs
of any defects that become apparent within 12 months after purchase. At 31st march 2013 TZS. 1000m of the
goods had been sold and none had been returned for repairs.

Required
Prepare notes for the financial accountant setting out and explaining how each of the above
matters should be accounted for and disclosed in the financial statements of Rambo for the
 QUESTION 4
During the year: Rambo sold goods with a warranty under which customers are covered for the
cost of repairs of any defects that become apparent within 12 months after purchase. At 31st
march 2013 TZS. 1000m of the goods had been sold and none had been returned for repairs.

In the year to 31 October 2016, the following information is relevant:

Standard warranty sales 2000 units
Extended warranty sales 5000 units
Selling price per unit (both) Tshs.1000
Cost of repair (average):
Major repair Tshs. 500
Minor defect Tshs. 100
Assume that sales of equipment are on 31 October 2016 and any warranty claims are made
end 31 October in the year of the claim. Assume a risk adjusted discount rate of 4%.
REQUIRED:
Shows the accounting treatment for the above warranty provision under IAS 37 Provisions,
contingent liabilities and contingent assets for the year ended 31 October 2016.
 Question 5
IAS 37 Provisions, Contingent Liabilities and Contingent Assets is an important standard regulating the recognition of
liabilities and the use of provisions. It has been especially useful in controlling the abuse of provisions to manage reported
earnings.

REQUIREMENT:

i.Definea provision and discuss in detail the three conditions that must be satisfied in order for a provision to be recognized
under IAS 37.

Discuss briefly how each of the following transactions and events should be recorded by Henmark pic in compliance with
ii.
the requirements of lAS 37,

iii.A
decision was taken by the beard of hennark pic shortly before the year-end to close down a division. The costs of the
closure are estimated to total 30 million. The decision was announced in principle, but detailed implementation plans have
not been made yet.

iv.Hermark pic has traditionally repainted is premises every five years. The next painting is due in a year's time. The entity
proposes to accrue as a provision the expected cost of repainting the premises.

v.Henmark plc has sold 5000 units of a product to a customer during the pask 12 months with a year warranty attaching.
Past experience has shown that 3% of goods sold require warranty repair at an average cost of TZS 200 per unit

vi.Henmark plc has guaranteed the debts of its associate company up to a maximum amount of TZS 3 Million. The associate

is in excellent financial health and the directors are of the opinion that it is unlikely the guarantee will ever be called in .
 Question 6
 The company manufactures and sells building equipment on which it gives a standard one
year warranty to all customers. The company has extended the warranty to two years for
certain major customers and has insured against the cost of the second year of the
warranty. The warranty has been extended at nil cost to the customer. The claims made
under the extended warranty are made in the first instance against Mayila and then Mayila
in tum makes a counter claim against the insurance company. Past experience has shown
that 80% of the building Equipment will not be subject to warranty claims in the first year,
15% will have minor defects and 5% will require major repair. Mayila estimates that in the
second year of the warranty, 20% of the items sold will have minor defects and 10% will
require major repair. In the year to 31 October20X7, the following information is relevant.

Standard warranty extended warranty Selling price per unit

(units) (units) (both) (TZS''000'')

Sales 2,000.00 5,000.00 1,000.00

Minor defect Major defect
TZS ''000'' TZS ''000''
Cost of repair (Average) 100 500
Required
(a) Discuss the principles involved in accounting for claims made under the above
warranty provision
(b) Shows the accounting treatment for the above warranty provision under IAS 37
Provisions, contingent liabilities and contingent assets for the year ended 31 October
20X7.
Question 7
On 1 January 20X6, Nipael spent TZS 5m on erecting
infrastructure and machinery near to an area of natural
beauty. These assets will be used over the next three years.
Nipael is well-known for its environmentally friendly behaviour
and is therefore expected to restore the site after its use.
The estimated cost of removing these assets and cleaning up
the area on 1 January 20X9 is TZS 3m.
The pre-tax, risk-specific discount rate is 10%. Nipael has a
reporting date of 31 December.

Required: Explain how the above should be treated in

the financial statements of Nipael.
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