Presentation on theme: "PwC Provisions, Contingent Liabilities and Contingent Assets"— Presentation transcript:
PwC Provisions, Contingent Liabilities and Contingent Assets
2 PwC Overview of session 1. Scope of application 2. Key concepts 3. Recognition 4. Measurement 5. Disclosures 6. Specific implications / Next steps 7. Questions
PwC Provisions, Contingent Liabilities and Contingent Assets 1. Scope of application
4 PwC Scope Covers accounting for all provisions and contingencies, excluding: –Social benefits provided by an entity for which it does not receive consideration that is approximately equal to the value of goods or services provided –Provisions resulting from financial instruments carried out at fair value –Provisions arising in relation to income taxes –Employee benefits (except those that arise as a result of a restructuring) –Provisions covered by another IPSAS
6 PwC Legal and constructive obligations Legal obligation = an obligation that derives from: –A contract (through its explicit or implicit terms); or –Legislation; or –Other operation of law Constructive obligation = an obligation that derives from an entity’s action where: –By an established pattern of past practice, published policies or sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and –As a result, the entity has created a valid expectation on the part of those other parties that it will discharge its responsibilities.
7 PwC Liabilities and provisions Liabilities = present obligations (legal or implicit) of the entity arising rom past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits or service potential Provisions = a special category of liabilities = liabilities of uncertain timing and amount –There must be a clear present obligation from a past obligating event
8 PwC Provisions Write-downs Provisions –On the liabilities side –Present obligations resulting from past events Write-downs –To reduce the carrying value of assets –E.g. write-down of inventories to net realisable value; write-down of property, plant and equipment to recoverable amount Provisions should not be recognised for future operating losses. An expectation of future operating losses is an indication that certain assets of the operation may be impaired. In this case, an enterprise tests these assets for impairment.
9 PwC Contingent liabilities and contingent assets Contingent liabilities = –Possible obligations 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 –Present obligations that arise from past events but are not recognised because: It is not probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation; or The amount of the obligation cannot be measured with sufficient reliability
10 PwC Contingent liabilities and contingent assets Contingent assets = possible assets 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 Guarantees = possible assets or liabilities that arise from past events and whose activation will be confirmed by the occurrence or non-occurrence of the object of the guarantee –Guarantees qualify as contingencies
PwC Provisions, Contingent Liabilities and Contingent Assets 3. Recognition
12 PwC Provisions - Recognition A provision should be recognised as a liability in the balance sheet and as an expense in the economic outturn account when: –An entity has a present obligation (legal or constructive) as a result of a past event; and –A reliable estimate can be made of the amount of the obligation; and –It is probable that an economic outflow of economic resources embodying economic benefits or service potential will be required to settle the obligation.
13 PwC Provisions - Recognition Decision Tree Present obligation as a result of an obligating event? Probable Outflow? Reliable estimate? Possible obligation? Remote? Start Provide Disclose contingent liability Do nothing yesno yes no
14 PwC Examples ItemTrue/False 1. Warranties given where some claims are more likely than not 2. Board decision which has not been communicated to those affected 3. Future operating losses 4. Pollution that an entity is obliged to clean up 5. Staff retraining needed as a result of law changes 6. Court case where a loss seems more likely than not 7. Repairs and maintenance 8. Single guarantee for which there is no probable outflow of economic benefits
15 PwC Specific application of recognition criteria Restructuring provisions –Programme which materially changes scope of business –Following two conditions need to be met to be recorded as provision Detailed plan identifying key features of programme and its implementation must exist at balance sheet date Must be valid expectation that business will undergo restructuring –Can only include direct expenses associated with restructuring programme; cannot relate to ongoing operation of business
16 PwC Specific application of recognition criteria Onerous contracts –Unavoidable costs of meeting obligation greater than economic benefits expected to be received –Should include all indirect benefits that are derived from the contract –A provision should be made for the present obligation net of recoveries – the unavoidable costs reflect the least net cost of exiting from the contract, which is the lower of: The cost of fulfilling it; and Any compensation or penalties arising from failure to fulfil it.
PwC Provisions, Contingent Liabilities and Contingent Assets 4. Measurement
18 PwC Measurement Best estimate at balance sheet date of amount needed to settle obligation If range is predicted with all the same likelihood of occurrence, mid point must be selected Large population of items – expected value measurement Anticipated cash flows must be discounted at risk free rate where changing value of money over time is material: -Carrying value of liability increases by imputed interest in each period; recognised as interest expense in income statement
19 PwC Measurement – Worked example A government medical laboratory provides diagnostic scanners with a one-year guarantee for parts and labour. Experience indicates that 70% of the diagnostic scanners will not be the subject of warranty claims, 25% will have minor defects and 5% will require replacement or major work. 100,000 units were provided in the current year. Major repair or replacing the unit costs approximately 25. Minor repairs cost 5 each.
20 PwC Measurement - Worked example The estimated warranty expense and the warranty provision should be determined by applying the probability of each outcome to the cost of each outcome as follows: Expected Value 70% x nil nil 25% x 100,000 x 5125,000 5% x 100,000 x 25125,000 Estimated warranty expense250,000 The warranty provision will be reduced to the extent of costs already incurred in respect of warranty claims on vacuum cleaners sold during the year.
21 PwC Measurement - Worked example The E.C. have litigation pending. Legal advice is that the E.C. will lose the case, and costs of € 1,200 in two years time are estimated. The appropriate discount rate is 4.5 %. Discount factor at 4.5% NPVCash flowsAdditional costs At inception ,099- Year , Year , Economic outturn account Balance sheet
22 PwC Other issues Reimbursement: –To be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation –The reimbursement should be treated as a separate asset –In the economic outturn account, the expenses relating to a provision may be presented net of the amount recognised for the reimbursement Use of provision: –A provision should be used only for expenditures for which the provision was originally recognised.
PwC Provisions, Contingent Liabilities and Contingent Assets 5. Disclosures
24 PwC Disclosures - Provisions Key disclosures required: –Accounting policies for each major type of provision (for example, warranties) –Movements in provisions during the period –Descriptions of contingent liabilities and contingent assets
25 PwC Disclosures - Guarantees Guarantees for pre-financing received for procurement and for grants Performance guarantees: –“Regular” performance guarantees: disclose –“Specific” guarantees related to performance guarantees: do not disclose but consider as they are automatically activated and are in essence a liability towards the contractor Guarantees given or received by the DG ECFIN for borrowings and loans Guarantees received by the DG BUDG when fines are disputed
PwC Provisions, Contingent Liabilities and Contingent Assets 6. Specific implications / Next steps
27 PwC Ensuring compliance with the new rules CaptionProvision under IPSAS 19? CommentsCurrent treatment Dismantlement of nuclear installations YesAnnual estimatesYes Pensions + employee benefits Yes Food-and-mouth disease YesMinimum in the range of possible outcomes – Maximum possible outcome disclosed Yes Legal disputesYesOn a case by case basisYes
PwC Provisions, Contingent Assets and Contingent Liabilities 7. Questions