CHAPTER 4

PROVISION CONTINGENT
LIABILITY
 • TO UNDERSTAND THE NATURE OF A
PROVISION.
• TO KNOW THE CONDITIONS FOR THE
RECOGNITION OF A PROVISION.
• TO KNOW THE MEASUREMENT OF A

•LEARNING PROVISION.
• TO IDENTIFY THE MEASUREMENT

OBJECTIVESCONSIDERATIONS FOR A PROVISION.

• TO KNOW THE REQUIREMENTS FOR THE
RECOGNITION AND CONTINGENT ASSET.
 PROVISION CONTINGENT
LIABILITY
• PROVISION – is an existing • The entity has a present
liability of uncertain timing or obligation, legal or
uncertain amount. constructive, as a result of a past
event.
• RECOGNITION OF PROVISION – • It is probable that an outflow of
PAS 37 paragraph 14,provides resource embodying economic
that a provision shall be benefits would be required to
recognized as a liability in the settle the obligation.
financial statements under the ff. • The amount of the obligation can
conditions: be measured reliably.
 PROVISION CONTINGENT
LIABILITY
• PRESENT OBLIGATION – may be • The entity has indicated to other
legal or constructive. It is fairly parties that it will accept certain
clear what a legal obligation is. responsibilities by reason of an
• LEGAL OBLIGATION – is an established pattern of past
obligation arising from a contract, practice, published policy, or a
legislation or other operation of sufficiently specific current
law. statement.
• CONSTRUCTIVE OBLIGATION – • And as a result, the entity has
is an obligation that is derived created a valid expectation on
from an entity’s action where: the part of other parties that it will
discharge those responsibilities.
 PROVISION
CONTINGENT LIABILITY
• Past event that leads to a present • This is the case where:
obligation is called obligating
event.

• The settlement of the obligation can be

enforced by law.
• OBLIGATING EVENT – is an event • The event creates valid expectations
that creates a legal or on the part of other parties that the
constructive obligation because entity will discharge the obligation, as
the entity has no realistic in the case of a constructive obligation
alternative but to settle the
obligation created by the event.
 PROVISION
CONTINGENT LIABILITY
PROBABLE OUTFLOW OF RELIABLE ESTIMATE
ECONOMIC BENEFIT
• PAS 37 provides that the use of
• For a provision to qualify for recognition,
must be not only a present obligation but
estimates is an essential part of
also a probable outflow of resources the preparation of financial
embodying economic benefits to settle the statements and does not
obligation. undermine their reliability.
• As a rule of thumb, probable means more
than 50% likely or substantially more. • Where no reliable estimate can be
• Possible means 50% or less likely to occur made, no liability is recognized.
• Remote means 10% or less likely to occur
or very slight occurrence.
 PROVISION
CONTINGENT LIABILITY
• MEASUREMENT OF • Illustration “ expected value “ method
PROVISION • An entity sells goods with a warranty
• The amount recognized as a under which customers are covered for the
provision should be the best cost of repairs of any manufacturing defect
estimate of the expenditures that becomes apparent within 6 months after
required to settle the present purchase.
obligation at the end of the If minors defects are detected in all
reporting period.. products sold, repair cost would be about
• Best estimate is the amount P1,000,000.
that an entity would rationally If major defects are detected in all product
pay to settle the obligation at sold, repair cost of P5,000,000 would result.
the end of reporting period or The entity’s past experience and future
to transfer it to a third party at expectations indicate that 75% of the good sold
that time. will have no defects, 20% will have minor
defects and 5% will have major defects.
 PROVISION
CONTINGENT LIABILITY
• The expected value or cost repairs is measured as follows:
• 75% sales None
• 20% sales P200,000
• 5% sales P250,000
• The total expected value or cost of repairs P450,000
 PROVISION
CONTINGENT LIABILITY
OTHER MEASUREMENT CONSIDERATIONS EXAMPLE OF PROVISION
• Risk and Uncertainties • Warranties
• Present value of obligation • Environmental contamination
• Future events • Decommissioning or abandonment
• Expected disposal of assets • Court case
• Reimbursement • Guarantee
• Changes in provision
• Use of provision
• Future operating losses
• Onerous contract
 PROVISION
CONTINGENT LIABILITY
EVENTS THAT MAY QUALIFY AS
RESTRUCTURING RESTRUCTURING INCLUDES:
• Sale or termination of a line of business.
• PAS 37, defines restructuring as a • Closure of business location in a region or
“program ” that planned and relocation of business activities from one
location to another or relocation of
controlled by management and headquarters from one country to another.
materially changes either the
• Change in management structure, such as
scope of business of an entity or
elimination of a layer of management or
the manner in which that business making all functional units autonomous.
is conducted.
• Fundamental reorganization of an entity
that has a material and significant impact
on its operation.
 PROVISION
CONTINGENT LIABILITY
Provision for restructuring
A constructive obligation for restructuring arises when two conditions are
present.
• The entity has a detailed formal plan • The entity raised a valid
for restructuring with the ff. expectation in the minds of those
a. The business being restructured affected that the entity will carry
b. The business location affected out the restructuring by starting to
c. The location, function and approximate implement the plan and
number of employees who will be announcing the mean features to
compensated for terminating their those affected by it.
employment.
d. Date when the plan will be implemented.
e. The expenditures that will be undertaken.
 PROVISION
CONTINGENT LIABILITY
AMOUNT OF RESTRUCTURING PROVISION CONTINGENT LIABILITY
Shall include direct expenditures defines in two ways:
• EXCLUDE expenditures from the • A contingent liability is a possible obligation.
restructuring provision. • A contingent liability is a present obligation.
• Treatment of contingent liability
• Cost of retaining or relocating
• Brief description of the nature of
continuing staff contingent liability.
• Marketing or advertising program • An estimates of financial effects
to promote new company image. • An indication of the uncertainties that
exist
• Investment in new system and
• Possibly of any reimbursement.
distribution network.