Ind AS 37-

Provisions, Contingent Liabilities, and Contingent Assets-Questions

More than 50% to 95%

5% to 50%
Example 1-A manufacturer gives warranties at the time of sale to purchasers of its product. Under
the terms of the contract for sale, the manufacturer undertakes to make good, by repair or
replacement, manufacturing defects that become apparent within three years from the date of sale.
On past experience, it is probable* (i.e., more likely than not) * that there will be some claims under
the warranties. It is assumed that a reliable estimate can be made of any outflows expected. How
this is to be treated in terms of provisions?
Present obligation as a result of a past obligating event – The obligating event is the sale of the
product with a warranty, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits in settlement – Probable for the
warranties as a whole.
Conclusion – A provision is recognized for the best estimate of the costs of making good under the
warranty products sold before the end of the reporting period.

*(The probability is more than 50%)

The interpretation of ‘probable’ in Ind AS 37 as ‘more likely than not’ does not necessarily apply
in other Ind AS.)

Example 2: Contaminated land and constructive obligation

An entity in the oil industry (having 31 March year-end) causes contamination and operates in a
country where there is no environmental legislation. However, the entity has a widely published
environmental policy in which it undertakes to clean up all contamination that it causes. The entity
has a record of honouring this published policy. It is assumed that a reliable estimate can be made
of any outflows expected.
Present obligation as a result of a past obligating event- The obligating event is the
contamination of the land, which gives rise to a constructive obligation because the conduct of the
entity has created a valid expectation on the part of those affected by it that the entity will clean up
contamination.
An outflow of resources embodying economic benefits in settlement- Probable.
Conclusion- A provision is recognized for the best estimate of the costs of clean-up.

Example 3: Offshore oilfield

An entity operates an offshore oilfield where its licensing agreement requires it to remove the oil
rig at the end of production and restore the seabed. 90% of the eventual costs relate to the removal
of the oil rig and restoration of damage caused by building it, and 10% arise through the extraction
of oil. At the end of the reporting period, the rig has been constructed but no oil has been extracted.
It is assumed that a reliable estimate can be made of any outflows expected.
Present obligation as a result of a past obligating event – The construction of the oil rig creates
a legal obligation under the terms of the license to remove the rig and restore the seabed and is thus
an obligating event. At the end of the reporting period, however, there is no obligation to rectify the
damage that will be caused by extraction of the oil.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognized for the best estimate of ninety percent of the eventual costs
that relate to the removal of the oil rig and restoration of damage caused by building it. These costs
are included as part of the cost of the oil rig. The 10% of costs that arise through the extraction of
oil are recognized when the oil is extracted.

Example 4: Closure of a division – no implementation before the end of the reporting period
On March 12, 20X1 the board of an entity decided to close down a division. Before the end of the
reporting period (March 31, 20X1) the decision was not communicated to any of those affected and
no other steps were taken to implement the decision. it is assumed that a reliable estimate can be
made of any outflows expected.
Present obligation as a result of a past obligating event – There has been no obligating event and
so there is no obligation.
Conclusion – No provision is recognized.

Example 5: Closure of a division – communication/implementation before the end of the

reporting period
On March 12, 20X1 (reporting date), the board of an entity decided to close down a division making
a particular product. On March 20, 20X1 a detailed plan for closing down the division was agreed
by the board; letters were sent to customers warning them to seek an alternative source of supply
and redundancy notices were sent to the staff of the division. It is assumed that a reliable estimate
can be made of any outflows expected.
Present obligation as a result of a past obligating event – The obligating event is the
communication of the decision to the customers and employees, which gives rise to a constructive
obligation from that date, because it creates a valid expectation that the division will be closed.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognized at March 31, 20X1 for the best estimate of the costs of
closing the division.

Questions:
Q 1 -X Cements Ltd. has three manufacturing units situated in three different states of India. The
board of directors of X Cements Ltd., in their meeting held on January 10, 20X1, decided to close
down its operations in one particular state on account of environmental reasons. A detailed formal
plan for shutting down the above unit was also formalized and agreed by the board of directors in
that meeting, which specifies the approximate number of employees who will be compensated and
expenditure expected to be incurred. The date of implementation of plan has also been mentioned.
Meetings were also held with customers, suppliers, and workers to communicate the features of the
formal plan to close down the operations in the said state, and representatives of all interested parties
were present in those meetings. Do the actions of the board of directors create a constructive
obligation that needs a provision for restructuring?
Q 2- An entity is a telecom operator. Laying of cables across the world is a requirement to enable
the entity to run its business. Cables are also laid under the sea and contracts are entered into for the
same. By virtue of laws of the countries through which the cable passes, the entity is required to
restore the sea bed at the end of the contract period. What is the nature of obligation that the entity
has in such a case?

Q 3-An entity sells goods with a warranty under which customers are covered for the cost of repairs
of any manufacturing defects that become apparent within the first six months after purchase. If
minor defects were detected in all products sold, repair costs of Rs. 1 million would result. If major
defects were detected in all products sold, repair costs of Rs. 4 million would result. The entity’s
past experience and future expectations indicate that, for the coming year, 75% of the goods sold
will have no defects, 20% of the goods sold will have minor defects and 5% of the goods sold will
have major defects. In accordance with the standard, an entity assesses the probability of an outflow
for the warranty obligations as a whole. Evaluate the amount of Provision.

Q 4- Entity XYZ entered into a contract to supply 1000 television sets for Rs. 20 Lakhs. An increase
in the cost of inputs has resulted into an increase in the cost of sales to Rs. 25 Lakhs. The penalty
for non- performance of the contract is expected to be Rs. 2.5 Lakhs. Is the contract onerous and
how much provision in this regard is required?

Q 5-X Beauty Solutions Ltd. is selling cosmetic products under its brand name ‘B’, but it is getting
its product manufactured from Y Ltd. It has an understanding (enforceable agreement) with Y Ltd.
that if the company becomes liable for any damage claims, due to any injury or harm to the customer
of the cosmetic products, 30% will be reimbursed to it by Y Ltd. During the financial year 20X1-
20X2, a claim of Rs. 30,00,000 becomes payable to customers by X Beauty Solutions Ltd. It is
virtually certain that the reimbursement from Y Ltd. will be received if X Beauty Solutions Ltd.
settles the liability towards its customers.

How should X Beauty Solutions Ltd. account for the claim that becomes payable?

Q 6- X Metals Ltd. had entered into a non-cancellable contract with Y Ltd. to purchase 10,000 units
of raw material at Rs. 50 per unit at a contract price of Rs. 5,00,000. As per the terms of a contract,
X Metals Ltd. would have to pay Rs. 60,000 to exit the said contract. X Metals Ltd. has discontinued
manufacturing the product that would use the said raw material. For that X Metals Ltd. has identified
a third party to whom it can sell the said raw material at Rs. 45 per unit.
How should X Metals Ltd. account for this transaction in its books of account in respect of the
above contract?

Q 7 -Marico has an obligation to restore environmental damage in the area surrounding its factory.
Expert advice indicates that the restoration will be carried out in two distinct phases; the first phase
requiring expenditure of Rs. 20 Lakhs to remove the contaminated soil from the area and the second
phase, commencing three years later from the end of first phase, to replant the area with suitable
trees and vegetation. The estimated cost of replanting is Rs. 35 Lakhs. Marico uses a cost of capital
of 10%. Marico has not recognized any provision for such costs in the past and today’s date is 31
March 20X2. The first phase of the clean-up will commence in a few months time and will be
completed on 31 March 20X3 when the first payment of Rs. 20 Lakhs will be made. Phase 2 costs
will be paid three years later from the end of the first phase. Calculate the amount to be provided
on 31st March 20X2 for the restoration costs.

Q 8- An entity becomes subject to an obligating event at the end of the year i.e. on 31st March 2021.
The entity is committed to an expenditure of Rs.100 Lakhs at the end of 10 years time as a result of
this event. An appropriate discount rate would be 8% p.a. Evaluate the amount of provision to be
shown as on 31st March 2023 also, show how the yearly change in the amount of provision is to be
reflected in the journal entries at the end of every year till 31st March 2023.