F3 Chapter 16 Provisions and ContingenciesProvided byAcademy of Professional Accounting (APA)Professional Accounting EducationCopyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台ACCA F3Financial Accounting (FA)财务会计第十六讲ACCA Lecturer: Carrie NICopyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 2D9: Provisions and Contingencies? Provisions? Contingent liabilities? Contingent assetsCopyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 3Provision Definition? A provision is a liability of uncertain timing or amount.? A liability is an obligation of an entity to transfer economic benefits as a result of past transactions or events.Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 4Provision RecognitionA provision should only be recognised (i.e., included in the financial statements) when:a) An entity has a present obligation (legal or constructive) as a result of past event;b) It is probable that an outflow of economic resources will be required to settle the obligation; andc) A reliable estimate can be made of the amount of the obligation.Unless all three conditions are met, not provision can be recognised.Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 5Provision Accounting treatmentThe provision represents both a cost to the business and a potential liability:? Dr Expense (SOPL)? Cr Provision (SOFP)The required provision will be reviewed at each year end and increased or decreased as necessary. To increase a provision:? Dr Expense (SOPL)? Cr Provision (SOFP)To decrease a provision:? Dr Provision (SOFP)? Cr Expense (SOPL)Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 6Provision Learning exampleGrass Co. is reviewing its warranty obligations. Based on sales during 20x7 it has established that if all lawnmowers sold required minor repairs, this would cost $1 million whereas if major repairs were required, this would cost $6 million.Grass Co. expects that 75% of lawnmowers will have no faults, 20% will need minor repairs and 5% major repairs.Requireda) What provision should be made in 20x7 and what accounting entry is needed to record it?b) What entry should be made in 20x8 assuming the provision required then is $0.75 million?c) What entry should be made in 20x9 assuming the provision required then is $0.3 million?Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 7Contingent LiabilityIAS 37 defines a contingent liability as the following:? A possible obligation that arises from past events and whose existence will be confirmed only the occurrence or non-occurrence of one or more uncertain future event not wholly within the control of the entity; or? A present obligation that arises from past events but is not recognised because:? It is not probable that an outflow of economic resources will be required to settle the obligation; or? The amount of the obligation cannot be measured with sufficient reliability.Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 8Contingent LiabilityContingent liabilities should be disclosed in the notes unless probability of an outflow of resources embodying economic benefits is remote.The required disclosures are:? A brief description of the nature of the contingent liability? An estimate of its financial effect? An indication of the uncertainties that exist? The possibility of any reimbursementCopyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 9Contingent LiabilityLearning exampleCompany A has entered into an agreement to act as guarantor on a bank loan taken out by Mr. Smith. Mr. Smith is a financially secure individual, and the directors are of the opinion that the chances of him defaulting on the loan are slim.How should company A account for this guarantee?Copyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 10Contingent LiabilityDecision TreeCopyright ? ACCAspace.comACCAspace 中国ACCA特许公认会计师教育平台 11Contingent LiabilityLearning exampleSam owns a business selling timber to trade customers only. During the year ended 30 June 20x6, a salesman from one of Sams biggest trade customers tripped over some unstuck timber and fell on the warehouse floor. Shortly before the year-end, Sam received a letter from the solicitor of the customer, stating that it was going to take Sam to court as a result of the accident. The letter stated that if Sam wanted to come to an arrangement out of court, the customer was willing to settle for $25,000; otherwise the customer would be claiming $50,000. Sams solicitor has advised him to settle out of court as there is a good change of the c