Presentation on theme: "Provisions, Contingent Liabilities and Contingent Assets"— Presentation transcript:
1Provisions, Contingent Liabilities and Contingent Assets
26. Specific implications / Next steps Overview of session1. Scope of application2. Key concepts3. Recognition4. Measurement5. Disclosures6. Specific implications / Next steps7. Questions
3Provisions, Contingent Liabilities and Contingent Assets 1. Scope of application
4ScopeCovers 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 providedProvisions resulting from financial instruments carried out at fair valueProvisions arising in relation to income taxesEmployee benefits (except those that arise as a result of a restructuring)Provisions covered by another IPSAS
5Provisions, Contingent Liabilities and Contingent Assets 2. Key concepts
6Legal and constructive obligations Legal obligation = an obligation that derives from:A contract (through its explicit or implicit terms); orLegislation; orOther operation of lawConstructive 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; andAs a result, the entity has created a valid expectation on the part of those other parties that it will discharge its responsibilities.
7Liabilities 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 potentialProvisions = a special category of liabilities = liabilities of uncertain timing and amountThere must be a clear present obligation from a past obligating event
8Provisions Write-downs On the liabilities sidePresent obligations resulting from past eventsWrite-downsTo reduce the carrying value of assetsE.g. write-down of inventories to net realisable value; write-down of property, plant and equipment to recoverable amountProvisions 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.
9Contingent liabilities and contingent assets 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 entityPresent 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; orThe amount of the obligation cannot be measured with sufficient reliability
10Contingent 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 entityGuarantees = 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 guaranteeGuarantees qualify as contingencies
11Provisions, Contingent Liabilities and Contingent Assets 3. Recognition
12Provisions - 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; andA reliable estimate can be made of the amount of the obligation; andIt is probable that an economic outflow of economic resources embodying economic benefits or service potential will be required to settle the obligation.
13Provisions - Recognition Presentobligation as a result of an obligating event?ProbableOutflow?Reliableestimate?Possible obligation?Remote?StartProvideDisclose contingent liabilityDo nothingnonoyesyesnoyesDecision Treeyesnonoyes
14Examples Item True/False 1. Warranties given where some claims are more likely than not2. Board decision which has not been communicated to those affected3. Future operating losses4. Pollution that an entity is obliged to clean up5. Staff retraining needed as a result of law changes6. Court case where a loss seems more likely than not7. Repairs and maintenance8. Single guarantee for which there is no probable outflow of economic benefits
15Specific application of recognition criteria Restructuring provisionsProgramme which materially changes scope of businessFollowing two conditions need to be met to be recorded as provisionDetailed plan identifying key features of programme and its implementation must exist at balance sheet dateMust be valid expectation that business will undergo restructuringCan only include direct expenses associated with restructuring programme; cannot relate to ongoing operation of businessExample: Relocation of a Directorate or of an Agency
16Specific application of recognition criteria Onerous contractsUnavoidable costs of meeting obligation greater than economic benefits expected to be receivedShould include all indirect benefits that are derived from the contractA 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; andAny compensation or penalties arising from failure to fulfil it.
17Provisions, Contingent Liabilities and Contingent Assets 4. Measurement
18MeasurementBest estimate at balance sheet date of amount needed to settle obligationIf range is predicted with all the same likelihood of occurrence, mid point must be selectedLarge population of items – expected value measurementAnticipated 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
19Measurement – 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.
20Measurement - 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 Value70% x nil nil25% x 100,000 x ,0005% x 100,000 x ,000Estimated warranty expense 250,000The warranty provision will be reduced to the extent of costs already incurred in respect of warranty claims on vacuum cleaners sold during the year.
21Measurement - 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 %.Economic outturn accountBalance sheetDiscount factor at 4.5%NPVCash flowsAdditional costsAt inception0.91571,099-Year 10.95691,14849Year 21.00001,20052
22Other issues Reimbursement: Use of provision: To be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligationThe reimbursement should be treated as a separate assetIn the economic outturn account, the expenses relating to a provision may be presented net of the amount recognised for the reimbursementUse of provision:A provision should be used only for expenditures for which the provision was originally recognised.
23Provisions, Contingent Liabilities and Contingent Assets 5. Disclosures
24Disclosures - Provisions Key disclosures required:Accounting policies for each major type of provision (for example, warranties)Movements in provisions during the periodDescriptions of contingent liabilities and contingent assets
25Disclosures - Guarantees Guarantees for pre-financing received for procurement and for grantsPerformance 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 contractorGuarantees given or received by the DG ECFIN for borrowings and loansGuarantees received by the DG BUDG when fines are disputed« Specific » guarantees: 10% deduction from payments made to contractors
26Provisions, Contingent Liabilities and Contingent Assets 6. Specific implications / Next steps
27Ensuring compliance with the new rules CaptionProvision under IPSAS 19?CommentsCurrent treatmentDismantlement of nuclear installationsYesAnnual estimatesPensions + employee benefitsFood-and-mouth diseaseMinimum in the range of possible outcomes – Maximum possible outcome disclosedLegal disputesOn a case by case basis
28Provisions, Contingent Assets and Contingent Liabilities 7. Questions