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2
Overview of session
1. Scope of application
2. Key concepts
3. Recognition
4. Measurement
5. Disclosures
6. Specific implications / Next steps
7. Questions
4
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
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.
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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
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
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
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
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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
Provisions - Recognition
Decision Tree
Present obligation as a result of an
obligating event?
Probable Outflow?
Reliableestimate?
Possible obligation?
Remote?
Start
ProvideDisclose contingent
liabilityDo nothing
yesno
no
nono
yes
yes
yesyes
no
14
Examples
Item True/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
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
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.
18
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
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
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 5 125,000
5% x 100,000 x 25 125,000
Estimated warranty expense 250,000
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
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%
NPV Cash flows Additional costs
At inception 0.9157 1,099 -
Year 1 0.9569 1,148 - 49
Year 2 1.0000 1,200 1,200 52
Economic outturnaccount
Balance sheet
22
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.
24
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
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
27
Ensuring compliance with the new rules
Caption Provision under IPSAS 19?
Comments Current treatment
Dismantlement of nuclear installations
Yes Annual estimates Yes
Pensions + employee benefits
Yes Yes
Food-and-mouth disease
Yes Minimum in the range of possible outcomes – Maximum possible outcome disclosed
Yes
Legal disputes Yes On a case by case basis Yes