MFRS 137 - PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

MFRS 137 discusses three situations, which are: Provisions Contingent liabilities, and Contingent assets

Provisions MFRS 137 defines a provision ‘as a liability of uncertain timing or amount or both’. A liability is defined by the standard as 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’.

Recognition A provision is recognised when: An entity has a present obligation (legal or constructive) as a result of a past event (obligating event); It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and A reliable estimate can be made of the amount of the obligation.

Obligations Two types: Legal and Constructive Legal obligation arises from: a contract, legislation, or other operation of law. Constructive obligation A constructive obligation is an obligation that derives from an entity’s actions where: 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; and as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

Factors to Consider Past Event (obligating event) Outflow of Economic Resources Reliable Estimate Examples 1 and 2 of the text book

Contingencies Contingencies are classified into: Contingent liability, and Contingent asset. Contingent liability The Standard defines contingent liability as: A possible obligation that arises from past events and whose existence will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events 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 resources embodying economic benefits will be required to settle the obligation, or the amount of the obligation cannot be measured with sufficient reliability.

Contingent liabilities can be classified as to: Probable, Possible, or Remote Probable contingent liability A contingent liability that is probable is considered a liability. Possible contingent liability Possible contingent liabilities should not be recognised but disclosed. Ignore Example 3 of text book

Contingent asset Contingent assets can be classified as to: Virtually certain, Probable, and Possible and remote Virtually certain It is an asset – recognise Probable Disclosure Possible or remote Ignore Example 4 of the text book

Measurement The following affect the amount of provisions (including contingent liabilities) to be recognised: Best estimates; Risks and uncertainties; Present value; Future events; and Expected disposal of assets. Examples 5 and 6 of the text book

Changes in Provision The provision is reviewed at each reporting date and adjusted where necessary for the current best estimate. The provision is reversed if the obligation is no longer required. Where the obligation was discounted, the unwinding of the interest is a borrowing cost.

Future Operating Losses An entity cannot make a provision for future operating losses as future operating losses do not meet the definition of a liability. Onerous Contracts An onerous contract is ‘ a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.’ Unavoidable cost is the net cost of exiting from the contract which is the lower of fulfilling the contract and paying the penalties or compensation from failing to fulfill it. Example 7 of the text book

Restructuring A restructuring is a ‘programme that is planned and controlled by management, and materially changes either: the scope of a business undertaken by an entity, or the manner in which that business is conducted’. Example 9 of the text book

There is a constructive obligation to restructure only when an entity: Has a detailed formal plan for the restructuring identifying at least: the business or part of the business concerned, the principal locations to be affected, the location, function and approximate number of employees who will be compensated for terminating their services, the expenditure that will be undertaken, and the time when the plan will be implemented. Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.

Restructuring Provision A restructuring provision will only include those expenditures that are both necessarily entailed by the restructuring, and not associated with the ongoing activities of the entity. The provision should not include cost of: retraining or relocating continuing staff, marketing, or investments in new systems and distribution networks.

Summary Present obligation Probable outflow of resources Reliable estimate of amount Provision Expense/ liability Yes No Contingent liability No/note Uncertain Disclose Possible Disclose as note Remote Ignore

Summary Degree of probability Contingent liability Contingent asset Certain/virtually certain Yes –expense/liability Yes –asset/income Probable Yes –expense/ liability Disclose by note Possible Ignore Remote