Provisions and Contingencies

Carolina Herrera Rosero

Juan Manuel Gmez Macias
Provisions

Provisions are a subset of liabilities. A liability is a present

obligation of the entity arising from past events (The
entity is required to pay), the settlement of which is
expected to result in an outflow from the entity of
resources embodying economic benefits. A provision is a
liability of uncertain timing or amount. Examples of
provisions include liabilities for warranties, lawsuits,
customer refunds, contracts, and plant closures and
restructurings.
Initial recognition
A provision is recognised only when a past event has created a present
obligation, an outflow of resources is probable, and the amount of the
obligation can be estimated reliably. Provisions are measured at the
best estimate of the amount required to settle the obligation at the
reporting date, and specified disclosures shall be given.
this section classifies obligations into two categoriesprovisions and
contingent liabilities. Those that meet the liability recognition criteria
are classified as provisions. Those that do not meet the recognition
criteria are classified as contingent liabilities.
The classification of obligations is important because provisions are
recognised in the entitys statement of financial position whereas
contingent liabilities are not recognised.
Recognition
An entity shall recognise a provision only when:
a. the entity has an obligation at the reporting date as a result of
a past event;
b. it is probable (ie more likely than not) that the entity will be
required to transfer economic benefits in settlement
c. the amount of the obligation can be estimated reliably.
The entity shall recognise the provision as a liability in the
statement of financial position and shall recognise the amount
of the provision as an expense, unless another section of this
IFRS requires the cost to be recognised as part of the cost of an
asset such as inventories or property, plant and equipment.
 start

Present obligation No Possible

as the result of an
obligation?
obligation event?

Yes Yes

Reliable Yes Probable No

No remote
estimate outflow

No No
Yes Yes

Disclose
provide contingent Do nothing
liability
example

A customer has initiated a lawsuit against an entity

associated with personal injury when using one of the
entitys products. The entitys lawyers estimate from
experience that at the reporting date (31 December 20X1)
has a 25 per cent chance of winning the lawsuit and
thereby avoiding the payment of compensation.
Furthermore, the entitys lawyers estimate that the entity
has a 35 per cent chance of being ordered to pay the
customer compensation of CU 2 million and a 40 per cent
chance of being ordered to pay compensation of
CU300,000.
example
The outcome of the case is expected to result in no compensation being
awarded or, if the case is lost, an outflow of CU2 million or CU300,000. The
individual most likely outcome is that compensation of CU300,000 will be paid
to settle the obligation. However, because the other possible outcomes are
mostly higher than the most likely outcome, the best estimate to settle the
obligation at 31 December 20X1 will be higher than the present value of the
most likely outcome of CU300,000. In accordance with the principle of
determining the amount required to settle the obligation at the reporting date
(31 December 20X1) it would be appropriate to recognise a provision at 31
December 20X1 of approximately CU820,000 (its expected value)(2) .
Calculation: Expected value: (CU0 25%) + (CU2,000,000 35%) + (CU300,000
40%) = CU820,000.
Types of contingents:

A contingent liability is either a possible but uncertain

obligation or a present obligation that is not recognised
because it fails to meet one or both of the conditions:
1. 1. the entity has an obligation at the reporting date as a
result of a past event
2. 2. and it is probable (ie more likely than not) that the
entity will be required to transfer economic benefits in
settlement
Types of contingents:

A contingent asset is a possible asset that arises from past

events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain
future events not wholly within the control of the entity.
Contingent assets are not recognised in the statement of
financial position. However, in specified circumstances,
they are disclosed in the notes.
 The relationship between provisions and
contingent liabilities is summarised as
follows:
there is a possible
obligation or a present
obligation that may, but there is a possible
there is a present
obligation or a present
obligation that probably probably will not, require
an outflow of resources. obligation for which the
requires an outflow of
likelihood of an outflow
resources. No provision is of resources is remote.
A provision is recognise. recognised.
No provision is
Disclosures are required Disclosures are required recognised.
for the provision. for the contingent
liability. No disclosure is required.
Example contingent liabilities

In a lawsuit brought against an entity, a group of people are collectively

seeking compensation for damages to their health as a result of
contamination to the nearby land believed to be caused by waste from that
entitys production process. It is doubtful whether the entity is the source of
the contamination because many entities operate in the same area producing
similar waste and it is unclear which entity is the source of the leak. The
entity denies any wrongdoing because it has taken precautions to avoid such
leaks and so it is vigorously defending the case. However, the entity cannot be
certain that it has not caused the leak and the true offender will become
known only after extensive testing. The entitys lawyers expect a court ruling
in about two years. If the entity loses the case, compensation is likely to be in
the range of CU1 million to CU30 million.
 Solution

On the basis of the facts above it may be uncertain whether the

entity has a present obligationthis is the matter being
determined by the court.
If taking account of all of the available evidence, it is probable
that the entity will successfully defend the court case then the
entity has a possible obligation and hence a contingent liability.
If taking account of all of the available evidence, it is probable
that the entity will lose the court case then the entity is
deemed to have a present obligation, and hence a liability of
uncertain timing or amounta provision
 Reference: IFRS Foundation Module 21-
Provisions and Contingencies
http://www.ifrs.org/IFRS-for-
SMEs/Documents/IFRS%20for%20SMEs%20Mo
dules/Module21__version%202013.pdf