PAS 37 Provision, Contingent Liability and Asset

Measurement Considerations
a. Risks and uncertainties
Provision - Risk describes variability of outcome.
● An existing liability of uncertain timing or amount - Practice prudence but do not have
excessive provisions
Conditions necessary for the recognition of a
provision as a liability b. Present value of obligation
- When the effect of the time value of
1. The entity has a present obligation, legal or money is material, the amount of
constructive, as a result of a past event. provision shall be the present value of
the expenditure expected to settle the
2. It is probable that an outflow of resources obligation
embodying economic benefits would be required
to settle the obligation. c. Future events
- Future events that affect the amount
3. The amount of the obligation can be measured required to settle an obligation shall be
reliably. reflected in the amount of a provision
where there is sufficient evidence that
they will occur
Legal obligation - obligation arising from a contract,
legislation, or other operation of law d. Expected disposal of assets
- If a company expects to sell an asset in
the future, the profit from that sale
Constructive obligation - exists when the entity from should not be included in the calculation
an established pattern of practice or stated policy has of a provision.
created a valid expectation that it will accept certain - The actual gain should only be
responsibilities recognized when the asset is sold, not
before.

Obligating event - The past event that leads to a e. Reimbursements

present obligation - If another party will cover some or all of
the costs associated with a provision,
the company should recognize this
Recognition expected reimbursement separately as
● For a provision to qualify for recognition, there an asset.
must be not only a present obligation but also a - Only recognize the reimbursement if it's
probable outflow of resources embodying sure that it will be received once the
economic benefits to settle the obligation. company pays for the obligation.
- Probable - More than 50% likely to - The reimbursement amount recognized
occur (more likely than not) should not be more than the provision
- Possible - 50% or less likely to occur itself.
- Remote - 10% or less likely to occur f. Changes in provisions
(very unlikely) - Provisions should be reviewed and
updated at the end of each reporting
Reliable Estimate period
- Increase if the obligation is still probable
● Using estimates is crucial for preparing financial but the estimated cost has gone up.
statements, and these estimates can still be - Decrease or reverse if it’s no longer
reliable even if they involve some uncertainty probable that an outflow of resources
● If the company cannot make a reliable estimate, will be needed to settle the obligation
then it should not recognize the liability in its - If the provision was discounted, it should
financial statements be increased each period to reflect the
passage of time, just like interest
growing.
Measurement
g. Use of provision
● The amount recorded should be the best - Use for the specific purpose only
estimate of what the company would pay to
settle the obligation or transfer it to someone h. Future operating losses
else - No provision allowed for expected future
- Single Obligation - If there's only one losses
possible outcome, use that outcome.
- Range of Outcomes - If multiple i. Onerous contract
outcomes are equally likely, use the - An onerous contract is when a company
midpoint of the range. is stuck with a contract where the cost of
- Large Population of Items - For multiple fulfilling it is more than the benefits it will
similar obligations, calculate by get. A provision must be made for this
weighting all possible outcomes with loss.
their possibility. - The provision should be based on the
lower cost of either fulfilling the contract
or the penalty for not fulfilling it

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Examples of Provisions
1. Warranties - The company has an obligation
because customers expect the company to
honor the warranty. A provision is set aside for
the estimated costs of future repairs or
replacements.
2. Environmental Contamination - If a company
causes pollution or environmental damage, it
may have to clean it up, especially if it has a
policy to do so or has broken environmental
laws.
3. Decommissioning or Abandonment Costs -
Companies, like oil companies, have a legal
obligation to clean up and restore sites when
they stop using them
4. Court Case - If a company is involved in a legal
case, and it’s likely it will have to pay damages,
it must prepare for that cost.
5. Guarantee - If a company guarantees another
company’s loan, it may have to pay if the
borrower cannot.

Contingent liability
● Potential obligation that depends on uncertain
future events
- Something might happen in the future
that will require the company to pay, but
it’s uncertain
- The company already has a
responsibility because of something that
happened in the past, but it either is not
probable that the company will have to
pay OR the amount the company would
need to pay can’t be measured reliably.

Contingent liability VS Provision

● Provision - recognized when a company has a
present obligation, it is probable that payment
will be required, and the amount can be
measured reliably
● Contingent Liability - If either the obligation is not
probable or the amount cannot be reliably
measured

Treatment of a contingent liability

● A contingent liability shall not be recognized in
the financial statements but shall be disclosed
only. But, if a contingent liability is remote, no
disclosure is necessary.

Contingent asset
● A possible future gain that depends on uncertain
events happening
● The company might receive a benefit or income,
but it is not certain yet

Treatment of a contingent asset

● Contingent asset should not be recognized
● Only when it becomes virtually certain that the
company will receive the asset or income, can it
be recorded in the financial statements
● If it’s probable that the company will gain the
asset, it should be disclosed