Provisions, Contingent Liabilities and

Contingent Asset
(BAS 37)

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Check list:
1. Definitions of ‘liability’, ‘provision’, ‘contingent liability’ and
‘contingent asset’.
2. Accounting for liabilities and provisions
3. Accounting for contingent liabilities and contingent assets
4. Demarcating liabilities, provisions, contingent liabilities
5. Thresholds on whether occurrence is probable, possible or remote
6. Calculate provisions and changes in provisions
7. Account for the movement in provisions
8. Reporting provisions in the financial statements

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Definition of liability
A liability is a present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits. (BAS 37 , Page 10)
An obligating event is an event that creates a legal or constructive
obligation that results in an entity having no realistic alternative to
settling that obligation.

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Recognition criteria of liability
Apart from satisfying the definition of liability, the following criteria
have to be fulfilled before a liability can be recorded in financial
statements:
a. The outflow of resources embodying economic benefits ( Such as
cash) from the entity is probable.
b. The cost/ value of the obligation can be measured reliably.
The first test requires liability to be recognized only it is likely that the
entity will be required to settle it. The second test ensures that only
liabilities that can be objectively measured are recognized in the
financial statements.
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Liability : Example
Trade payable

There is a present Settlements requires an

obligation as a result of past events, outflow of economic
Goods were purchased on credit benefits in future (Cash)
Because of which at present there is a present
Obligation to make payments.

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Accounting for liability
Inventory Account ………………….Dr.
To trade payable Account

Note: If the cash payments is probable and the amount can be

measured reliably.

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 Provisions: Meaning and Definition

• BAS37 defines provisions as liabilities of uncertain timing or amount.

• Recognition criteria of provisions.

A provision should be recognised when, and only when:
(a) an entity has a present obligation (legal or constructive) as a result of a
past event;

(b) it is probable (i.e. more likely than not) that an outflow of resources
embodying economic benefits will be required to settle the obligation;
and
(c) a reliable estimate can be made of the amount of the obligation. (The
Standard notes that it is only in extremely rare cases that a reliable
estimate will not be possible). 7
 Meaning and Definition:

The Standard defines a constructive obligation as an obligation that

derives from an entity’s actions where:

(a) by an established pattern of past practice, published policies or a

sufficiently specific current statement, the entity has indicated to other
parties that it will accept certain responsibilities (e.g. product
warranties); and

(b) as a result, the entity has created a valid expectation on the part of
those other parties that it will discharge those responsibilities.

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 Meaning and Definition- EXAMPLE
(Warranties)

Hyundai Motors in Korea is a car manufacturer who gives warranties to

its clients at the time of purchase. Under the terms of sale contract,
Hyundai Motors undertakes to repair manufacturing defects or replace
defective parts that become apparent within 5 years from the date of sale.
Based on previous experience, it is probable that there will be some
claims under warranties.
Should Hyundai Motors recognize any provision?

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 Recognition of provision- EXAMPLE

Assessment

Present obligation as a result of past event? yes - sale

Outflow of economic benefits probable? yes

Reliable estimate? yes

Recognize provision (best

estimate of the costs of making
goods under the warranty products
sold
before the end of period)
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 Recognition of provision- EXAMPLE

Warranty Expense Dr
To Liability - provision Cr
(providing a liability provision)

Liability - provision Dr
To cash / bank etc Cr
(payment of provision)

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 Recognition of provision- EXAMPLE
(Constructive obligations )

Druk Petro Chemicals operating in chemical industry in the region

regularly causes contamination of land and water, but has widely
published its environmental policy in which it undertakes to clean up
all contamination. Druk Petro Chemicals operates also in the
countries without any environmental legislation.
Should Druk Petro Chemicals recognize any provision for clean-up of
land and water also in countries without applicable laws?

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 Recognition of provision- EXAMPLE
(Constructive obligations )

Assessment
Present obligation as a result of past event? yes - contamination of land

Outflow of economic benefits probable? yes

Reliable estimate? yes

Recognize provision
(best estimate of the
costs for clean up)

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 Recognition of provision- EXAMPLE
(Constructive obligations )

Housemake Co, home appliances retailer, has a generally known

policy of refunding purchases by unhappy customers even though it
is not required by law.
Should Housemake Co recognize any provisions for refunds?

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 Recognition of provision- EXAMPLE
(Constructive obligations )

Assessment
Present obligation as a result of past event? yes - sale

Outflow of economic benefits probable? yes

Reliable estimate? yes

Recognize provision
(best estimate of the
costs for refund)

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 Recognition of provision- EXAMPLE
(Repair and Maintenance)

Bhutan Airlines, an airline company, needs to replace seats in its aircraft

every 5 years. At the end of 2017, the seats have been in use for 3
years.
Also, Bhutan Airlines is required by law to overhaul (repair) its aircraft
once every 3 years.
Should Bhutan Airlines recognize provision for replacement of seats or
overhauling as at 31 December 2017?

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 Recognition of provision- EXAMPLE
(Repair and Maintenance)
Assessment
Seats Overhauling
Present obligation as a result of past event? NO NO

Outflow of economic benefits probable? N/A N/A

Reliable estimate? N/A N/A

No provision No provision

NOTE: Unlike legal and constructive obligations, repair and maintenance

does not involve any outside obligation

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Contingent liabilities
Contingent liabilities are defined as:
a. A possible obligation that arise 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; or
b. A present obligation that arise 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 the obligation cannot be measured with sufficient
reliability.

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Reporting of contingent liabilities in financial
statement
Contingent liabilities should not be recognized in financial statement
but should be disclosed as notes unless the possibility of an outflow of
resources is remote.

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Summarizes the key requirements of BAS 37 in relation to contingents liabilities

Obligation/ probability Treatment

Obligation and probability of outflow of economic benefits Accounting treatment in accordance with BAS 37

Present obligation that probably require an outflow of A provision is recognized

resources

Present obligation that may (but probably will not) require Disclosed as a contingent liability
an outflow of resources

Present obligation where the likelihood of outflow of No disclosure required

resources is remote

Possible obligation Disclosed as a contingent liability

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Contingent Assets
Contingent assets are possible assets 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 recognized in the statement of financial
position. They are disclosed in the notes to the financial statements.
An example of contingent asset is a claim that an entity is pursuing
through legal processes, where the outcome is uncertain.

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Summarizes the key requirements of BAS 37 in relation to contingent assets:

Probability Treatment

Probability of inflow of economic benefits Accounting treatment in accordance with BAS 37

Virtually certain When the realization of income is virtually certain,

the assets is not a contingent assets and it is
appropriate to recognize the asset.

Probably (but not virtually certain) If future benefits are probable, but not virtually
certain, contingent assets is disclosed.

Not Probable If, inflow of economic benefits are not probable, no

disclosure is required for the contingent assets.

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 Contingencies

Contingencies

Contingent liabilities Contingent assets

possible obligation present obligation Possible asset

+ +
outflow possible (not probable) or Inflow is possible
not reliably measurable

DISCLOSURE REQUIRED
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 Contingent liability-EXAMPLE

Kuenzang & Dechen Restaurant at Laptsakha organized birthday party for 20 GCBS
students where dry pork, emadhatsi and fried noodles were served. After the party, 8
students went to hospital suffering from food poisoning and their teachers believe
that it is due to dry pork not cooked properly.
Parents are now suing Kuenzang & Dechen and Lawyer of this Restaurant believes
that based on past similar court cases and insufficient evidence against Kuenzang &
Dechen Restaurant there is 60% chance of losing the case and Kuenzang & Dechen
Restaurant would have to pay Nu.160,000 to indemnify students for poisoning.

What should Kuenzang & Dechen Restaurant do in its financial statements in relation
to this claim?

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 Contingent liability-EXAMPLE

Assessment
Present obligation as a result of past event? no - just possible obligation

Outflow of economic benefits probable? no

Reliable estimate? yes

Disclose contingent liability

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The End

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