UNIVERSITY OF JOHANNESBURG

DEPARTMENT OF ACCOUNTANCY
POSTGRADUATE DIPLOMA IN ACCOUNTING SCIENCE

ACCOUNTING IV
2025

MODULE 2

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

[IAS 37]

EVENTS AFTER THE REPORTING PERIOD

[IAS 10]

TABLE ON CONTENTS PAGE

A. General 2

B. Framework 3

C. Outcomes 7

D. Specific issues 7

E. Illustrative examples 17

F. Illustrative disclosure 24
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A. GENERAL

1. Importance of the topic

This topic is extremely important and addresses certain key concepts in Accounting. Students
should once again remember that the principles learnt in this module and the corresponding
Standards should be linked to the conceptual framework (new and old) and students
should not attempt to learn off by heart when these principles are applied, but rather
understand the logic supporting these principles.

From an exam technique point of view, students should realise that applying the principles
and/or requirements of the standard is critical to score marks for theory questions. We want to
test your thought process in applying the standard and not necessarily your conclusion. With
IAS 37 and IAS 10, there can be a lot of information given in a test. As a result, students
should not get overwhelmed in a test, and should break the question down in order to apply
the principles of the standards. Use the mark allocation as a guideline to determine how much
to write. Don’t forget to conclude!

2. Study material

• IAS 37 Provisions, Contingent Liabilities and Contingent Assets including all the
illustrative examples
• IAS 10 Events after the Reporting Date

3. Foreknowledge

You have already studied the following:

• the principles of IAS 37 and IAS 10; and

• the application of IAS 37 and IAS 10 in questions.

4. Study outcomes

After the completion of this document and the related study material, you should be able to:

• identify whether IAS 37 and IAS 10 are applicable in a specific scenario;

• justify your understanding of all the principles of IAS 37 and IAS 10;
• apply IAS 37 and IAS 10 in advanced discussion and application-type questions.

5. Examination possibilities

IAS 37 and IAS 10 can also be combined with an Auditing question. IAS 37 and IAS 10 are
often included in calculation-type questions. IAS 37 and IAS 10 are however usually
examined in discussion-type (application) questions, where information is provided and
students are required to supply the correct proposed accounting treatment.

NB! Remember to follow the correct accounting treamtment procedures for discussion type
questions by using the following ICRM (PD) approach:

- Identification
- Classification
- Recognition
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- Measurement(Initial and Subsequent Measurement )
- Presentation
- Disclosure

ie. If a question requires the discssion of recognition, it is important to follow the accounting
treatment procedures and discuss identification, classification first before discussing
recognition.

A question may require students to provide the financial statements and notes to the financial
statements. Information may be supplied (for example in respect of events after the reporting
period date) where students should decide whether or not to adjust the relevant financial
statements. Should it be decided not to adjust the financial statements, it should be borne in
mind that the necessary note disclosures must nevertheless be supplied. IAS 37 and IAS 10
can therefore also be examined indirectly by means of disclosure.

B. FRAMEWORK

In case of discussion (application-type/theory) questions relating to IAS 37 and IAS 10, the
use of the following framework is recommended as a basis for your suggested answer – the
framework is based on the key elements of the definition of a liability as per the conceptual
framework:
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A. Provisions (A liability with uncertainty relating to the timing or amount of the liability)

Justification of the liability element in terms of the conceptual framework

❑ Present obligation
- “no realistic alternative but to settle the obligation”, i.e. settlement cannot be avoided as
at reporting date
- legal or constructive obligation – is a constructive obligation a present obligation?

❑ “Lawsuits” (IAS 37.16)

- There might be disputes on whether certain events have occurred or whether those event
results in a present obligation.
- Take into account all available evidence including, for example, the opinions of the
experts.

❑ As a result of a past event – referred to as the “past obligating event”

- if after reporting period, such an event would represent an event after the reporting
period (this is the opposite of a past event)
- what event causes there to be a present obligation for the entity?
- how does this event create a present obligation for the entity?

❑ “Avoidance test” (IAS 37.19)

- can the entity avoid liability by doing/not doing something in the future?
- if yes, the entity’s not liable at present and has realistic alternative than settling (thus
entity not presently obligated)
- very important test = forms the crux of the Standard

❑ Expected to result in an outflow of future economic benefits (FEB)

- economic benefits are expected to flow out of the enterprise
- therefore a party must exist that will receive these benefits – who is paid?

❑ Recognition criterion of probability of outflow of benefits

- “more likely than not” that benefits will flow out
- If not probable, a contingent liability

❑ Measurement of obligation
- recognition criteria of “reliable measurement” or “reliable estimation”
- if not reliably measurable/estimatable – a contingent liability
- measurement requirements in the standard IAS 37

Classification of the liability in terms of IAS 37

❑ Classification as a liability, provision or contingent liability

- done in terms of IAS 37 based on extent of uncertainty
- no uncertainty = liability
- uncertainty about timing or amount = provision
- definition not met OR one or both of recognition criteria not met = contingent liability
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B. Contingent liabilities

Two types of contingent liabilities

❑ Uncertainty exists regarding present obligation – confirmation thereof is dependent on future

information (a “contingency” or “possible obligation”)
or
❑ Present obligation exists, but uncertainty regarding recognition criteria:
- probability of outflow of benefits in future, or
- reliable measurability of the amount of the benefits that may flow out (not even reliably
estimated)

C. Contingent assets

❑ The event that creates the asset takes place before reporting date (i.e. a “past entitling event”)
❑ Confirmed by uncertain future events (contingencies)
❑ Only when virtually certain that benefits will flow, becomes an asset and is recognised like
other assets

D. Events after the reporting date

❑ Adjusting events – the event that creates the adjustment must relate to a condition
surrounding an asset/liability that already existed before/at the reporting period (i.e. condition
existed at the reporting period)

❑ Non-adjusting events – the event that creates the adjustment does not relate to a condition
surrounding an asset/liability that existed before/at the reporting period (i.e. the condition
only arose after the reporting period)

E. Specific issues to consider

❑ Reimbursements – not taken into account to determine net provision

❑ Onerous contracts – very important and pervasive principle
❑ Restructuring provisions (in conjunction with IFRS 5 Non-current assets held for sale and
IAS 19 Employee Benefits relating to Termination Benefits)
❑ Disclosure
❑ Dividend declarations – why no obligation until dividend is declared?
❑ Going concern principle – IAS 10: automatically an adjusting event after the reporting date
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Diagram 1

Court cases (or similar circumstances)

i.e. when a dispute exists as to whether certain events have occurred

Therefore - uncertainty regarding whether there is a

present obligation

Now consider IAS 37.15 and .16

The legal advisers’ opinion is utilised to

determine existence of present obligation
This is based on “probability” and is called
a deemed present obligation if probable

Deemed present No deemed

obligation exists present obligation

Consider recognition criteria Contingent

➢ Probability (“more likely than not”) liability?
➢ Reliable measurement/estimation (prudence)

Diagram 2

Dilution of an obligation
LIABILITY (strongest obligation – no uncertainty) (recognised)

 If uncertainty exists regarding:

1. timing (i.e. when will cash flow take place), or
2. amount (i.e. how much will flow?) BUT definition of liability is met (i.e. no uncertainty
about present obligation or “deemed” present obligation exists based on probability)

PROVISION (medium-strength obligation) (recognised)

 If there is uncertainty regarding the

1. definition (i.e. not even a “deemed” present obligation can be determined), or
2. one/both of recognition criteria (i.e. not probable or not reliably measured/estimated)

CONTINGENT LIABILITY (weakest obligation) (only disclosed, unless possibility remote)

 NB: Never recognised, except in business combinations (IFRS 3), but this contradicts the
framework
 Only disclosed, unless possibility remote
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C. OUTCOMES

Firstly, it is important that in respect of a probable liability, you should be able to:

❑ know when a provision should be recognised (use the given framework for this);
❑ identify when that situation should rather be classified as a contingent liability; and
❑ identify events after the reporting date.

The abovementioned possibilities will be determined by applying the recognition

requirements for a provision. The recognition requirement of a “past obligating’ event” is
extremely important as this determines whether an item would be a provision, a contingent
liability or a non-adjusting event after the reporting date. This also means that should the
event creating a possible liability for an enterprise take place after reporting date (i.e. there is
no past obligating event), it becomes an event after the reporting period and it is very
important to be able to decide whether this subsequent information should affect measurement
in the financial statements or merely measured or disclosed for usefulness.

The requirements for the recognition of a provision in the financial statements:

❑ the existence of a present obligation due to a past ‘obligating’ event;

❑ expected probable outflow of future economic benefits; and
❑ reliable measurement/estimation of the expected future economic benefit outflow.

It is now important to determine whether a provision should be recognised or a contingent

liability should be disclosed.

You must be able to identify and apply every requirement in a discussion (application-type)
question.

Secondly, you should be able to decide when an asset should be recognised, whether a
contingent asset should be disclosed or if an event after the reporting date exists that should be
measured or disclosed.

Thirdly, you should be able to understand and identify the specific issues identified and how
to apply them to the information provided in questions.

For the above purposes, a thorough knowledge of the principles of Standards IAS 37 and
IAS 10 is required.

D. SPECIFIC ISSUES

IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

(a) Reimbursements

If the provision is to be reimbursed by another party:

❑ the reimbursement is recognised as a receivable, when it is virtually certain that it will

be received. The measurement of the provision is not amended for reimbursements.
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The reimbursement represents:

❑ a separate asset; and

❑ should not exceed the amount of the provision.

The other income and the expense may be offset when PRESENTED in the profit and loss
section of the statement of profit or loss and other comprehensive income. The asset and
liability may not be offset in the statement of financial position.

Dr Expense (P/L) XXX

Cr Provision for … (F/P) XXX
Dr Receivable (F/P) XXX
Cr Other income (P/L) XXX

(b) Future operating losses

❑ Not recognised ever, because there is no present obligation due to a past event. The past
obligating event would be the operating activities that create the loss. Remember that
the avoidance test is very important here as well. As at reporting date, the entity can still
avoid the operating losses in future by altering activities in such a way that the losses
are avoided etc. Read IAS 37.19 very carefully in this regard.

(c) Onerous contracts

❑ It is a contract where the unavoidable costs of meeting the obligation exceed the
expected economic benefits expected to be received under it. If the contract becomes
onerous, the present obligation under the contract shall be recognized and measured as a
provision.

The provision shall be measured at the lower of:

• the loss that would be incurred by specific fulfilment of the contract; and
• the loss incurred if the contract were to be cancelled and the payment of fines associated
with the cancellation enforced.

EXAMPLE

Penalties for early cancellation = R150

Expected Economic Benefits from fulfilment = R200
Costs if contract is fulfilled = R250

SOLUTION

Exiting the contract Fulfilling the contract

Economics benefits R0 R200
Penalties/Cost (R150) (R250)
Loss (R150) (R50)

- Choose smaller of the loss. Create provision at R50.

The onerous contract requirements in IAS 37 only apply to short-term leases and leases for
which the underlying asset is of low value. All other leases are dealt with in terms of IFRS 16
as that specific standard deals with leases and any onerous aspect of those leases.
 -9-
The IASB clarified that cost to fulfil includes incremental costs of fulfilling that contract and an
allocation of other costs directly related to fulfilling contracts. Check out the short video and page
from KPMG: https://home.kpmg/xx/en/home/insights/2019/01/onerous-contract-assessment-
exposure-draft-ias37-141218.html

Below is a summary of the video: Onerous contract

How do we decide the contract is onerous?

- The contract is onerous when: the unavoidable cost of meeting the contract obligation
outweighs the economic benefits. (IAS 37.68)

Which costs are unavoidable? (IAS 37. 68)

- The unavoidable cost is the lower of:
o The PV of the net costs to fulfil the contract OR
o The cost to terminate the contract

What are the costs to fulfilling a contract ?

- It is the costs that relates directly to the contract.
- It is the incremental costs ie. the direct material and labour costs and the allocation of the
other costs that relate directly ie. Depreciation of machinery used under the contract.

Before you recognise a provision for an onerous contract, you need to impair any asset that relates
directly to the contract.

This below also illustrates the interplay between impairment and onerous contract provisions – IAS
37.69.

Example: Onerous revenue contract

Ignore VAT

Penco entered into a non-cancellable contract with Writeco on 1 September 2022 to supply Writeco
with 100 000 specially branded pens each year for two years. The total contract price is R1 million
and the cost to fulfil the contract is R700 000. In addition to this, a special press was purchased on 1
September 2022 for R200 000 in order to produce the special pens. This press has a useful life
equal to the length of the contract and can only be used within this contract. Due to the specialized
nature of this press, there is no market for it to be resold (fair value less cost to sell is negligible). At
inception, the contract was profitable.

Half of the pens were delivered on 31 August 2023 and the contract price was received on the same
date and the other half is expected to be delivered and paid for in the next financial year. The costs
of fulfilling the contract are incurred in proportion to the pens delivered.

During the current financial year, Penco had to incur R200 000 on a special press brake tooling kit
and will have to incur another R200 000 in the following financial year in order to fulfil the
contract.
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At inception of the contract, the contract is projected to be profitable:

R
Revenue 1 000 000
Expenses
- Costs to fulfill the contract (700 000)
- Depreciation of special press (200 000)
Profit 100 000

Journal entries:

Year ended 31 August 2023 (Assume there is no significant

financing component)

1 September 2022
Dr Machinery R200 000
Cr Bank R200 000

31 August 2023
Dr Bank R500 000 500 000
Cr Revenue R500 000
Step 5 of IFRS 15 recognition is at point in time when pens are
delivered
-350 000
Dr Cost of sales R350 000
Cr Bank/creditor R350 000
Purchase of pens/manufacture of pens
-100 000
Dr Depreciation/cost of sales R100 000
Cr Accumulated depreciation R100 000
Depreciation is part of cost of sales
-200 000
Dr Cost of sales R200 000
Cr Bank R200 000
Purchase of Special press brake tooling kit
-100 000
Dr Impairment loss R100 000
Cr Accumulated impairment R100 000
Recognition of impairment loss

At 31 August 2023, the contract appears onerous:

• The contract is non-cancellable; therefore, there is
unavoidable costs
• The unavoidable costs exceed the economic benefits.
• However, before a separate provision for an onerous contract
is established, an entity recognises any impairment loss that
has occurred on assets dedicated to that contract (IAS 37.69).
• The impairment loss is calculated as follows:
Carrying amount of machinery 100 000
Recoverable amount, higher of
o FVLCTS 0
o Value -in-use 0 0
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Impairment loss 100 000
• Value-in-use calculated as:
Cash inflows 500 000
Cash outflows: costs to fulfil (350 000)
Cash outflows: Special press brake tooling kit (200 000)
Net cash outflow (50 000)
Therefore, value-in-use limited to zero.
Note: Depreciation – not included in value-in-use calculation as it is
non-cash flow
Note: Refer to value in use calculation notes below -50 000

Dr Onerous contract expense R50 000

Cr Onerous contract provision R50 000

At 31 August 2023, the contract appears onerous:

• The contract is non-cancellable; therefore, there is
unavoidable costs
• The unavoidable costs of R550 000 (350 000 + 200 000)
exceed the economic benefits R500 000. = -300 000
• Therefore, onerous element is R50 000.
Note: No depreciation included in onerous cost calculation, because
the special press is impaired to zero.

Year ended 31 August 2024

Dr Bank R500 000

Cr Revenue R500 000 500 000
Step 5 of IFRS 15 recognition is at point in time when pens are
delivered

Dr Cost of sales R350 000 -350 000

Cr Bank R350 000
Purchase of pens/manufacture of pens

Dr Cost of sales R200 000 -200 000

Cr Bank R200 000
Purchase of Special press brake tooling kit

Dr Depreciation/cost of sales R0 0
Cr Accumulated depreciation R0
Nil as the machinery was impaired.

Dr Onerous contract provision R50 000

Cr Onerous contract expense R50 000 50 000
Reversed when contract comes to an end
=0

Additional notes:
• This is a revenue contact (IFRS 15). IFRS 15 does not include requirements for identifying,
recognising and measuring onerous contract provisions. Instead, paragraphs 5(g) of IAS 37 and
BC296 of IFRS 15 states that an entity applies IAS 37 to assess whether a contract to which it
applies IFRS 15 is onerous.
 - 12 -
• IFRS 15.101 also states in so far as it relates to contract assets, that an entity shall recognise an
impairment loss in profit or loss to the extent that the carrying amount of an asset recognised in
accordance with paragraph 91 or 95 exceeds:
a) the remaining amount of consideration that the entity expects to receive in exchange for the
goods or services to which the asset relates; less
b) the costs that relate directly to providing those goods or services and that have not been
recognised as expenses (see paragraph 97).
• IASB clarified that cost to fulfil includes incremental costs of fulfilling that contract and an
allocation of other costs directly related to fulfilling contracts.

• Value in use calculations (IAS 36. 31): IAS 36 states that the estimating/ calculation of value
in use of an asset involves the estimating of the future cash inflows and cash outflows to be
derived from continuing use of the asst and from its ultimate disposal.

The above example resulted in an impairment loss of R100 000 and onerous contract provision of
R50 000 on 31 August 2023.

Is it possible that there is only an impairment loss and no onerous contract provision?

Yes. Let’s assume the same information as the above example, except that the Special press brake
tooling kit costs for the 2024 financial year is R150 000 and not R200 000 as originally stipulated:

Journal entries:

Year ended 31 August 2023

1 September 2022
Dr Machinery R200 000
Cr Bank R200 000

31 August 2023
Dr Bank R500 000
Cr Revenue R500 000 500 000
Step 5 of IFRS 15 recognition is at point in time when pens are
delivered

Dr Cost of sales R350 000 -350 000

Cr Bank/creditor R350 000
Purchase of pens/manufacture of pens

Dr Depreciation/cost of sales R100 000 -100 000

Cr Accumulated depreciation R100 000
Depreciation is part of cost of sales

Dr Cost of sales R200 000 -200 000

Cr Bank R200 000
Purchase of Special press brake tooling kit

Dr Impairment loss R100 000 -100 000

Cr Accumulated impairment R100 000
Recognition of impairment loss
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At 31 August 2023, the contract appears onerous:
• The contract is non-cancellable; therefore, there is
unavoidable costs
• However, before a separate provision for an onerous contract
is established, an entity recognises any impairment loss that
has occurred on assets dedicated to that contract (IAS 37.69).
• The impairment loss is calculated as follows:
Carrying amount of machinery 100 000
Recoverable amount, higher of
o FVLCTS 0
o Value -in-use 0 0
Impairment loss 100 000
• Value-in-use calculated as:
Cash inflows 500 000
Cash outflows: costs to fulfil (350 000)
Cash outflows: special press brake tooling kit (150 000)
Net cashoutflow 0
Therefore, value-in-use is zero.

Dr Onerous contract expense R0

Cr Onerous contract provision R0
0
At 31 August 2023, the contract appears onerous:
• The contract is non-cancellable; therefore, there is
unavoidable costs
• The unavoidable costs of R500 000 (350 000 + 150 000) is
equal to the economic benefits R500 000.
• Therefore, onerous element is R0.
• The impairment loss recognised of R100 000 means that the
costs of fulfilling the contract excludes the depreciation for
2024. The loss in the contract is already recognised by way of
impairment.
= -250 000
Year ended 31 August 2024

Dr Bank R500 000

Cr Revenue R500 000 500 000
Step 5 of IFRS 15 recognition is at point in time when pens are
delivered

Dr Cost of sales R350 000 -350 000

Cr Bank R350 000
Purchase of pens/manufacture of pens

Dr Cost of sales R150 000 -150 000

Cr Bank R150 000
Purchase of Special press brake tooling kit

Dr Depreciation/cost of sales R0 0
Cr Accumulated depreciation R0
Nil as the machinery was impaired.
 - 14 -
Dr Onerous contract provision R0
Cr Onerous contract expense R0 0
Reversed when contract comes to an end
=0

From the revised example, you can see the interplay between impairment and onerous contract
provisions.

- Before a separate provision for an onerous contract is established, an entity recognises any
impairment loss that has occurred on assets dedicated to that contract (IAS 37.69).
- This includes all assets, including contract assets in IFRS 15. If no impairment was first
recognised, the unavoidable costs of R600 000 (350 000 + 150 000 + 100 000 (depreciation
for 2024)) would have exceeded the economic benefits R500 000, resulting in an onerous
element of R100 000. But instead, IAS 37.69 leads to an impairment loss of R100 000 and
then zero onerous contract provision.
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(d) Restructuring provisions (important link with IFRS 3 Business Combinations)

❑ Restructuring: it 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.

❑ A constructive obligation to restructure arises only when an entity:

● has a detailed formal plan, and

● 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.

(e) Interest and penalties related to income taxes

IFRIC Update – September 2017:

IFRS Standards do not specifically address the accounting for interest and penalties related to
income taxes (interest and penalties). In the light of the feedback received on the draft IFRIC
Interpretation Uncertainty over Income Tax Treatments, the Committee considered whether to
add a project on interest and penalties to its standard-setting agenda.

On the basis of its analysis, the Committee concluded that a project on interest and penalties
would not result in an improvement in financial reporting that would be sufficient to outweigh
the costs. Consequently, the Committee decided not to add a project on interest and penalties
to its standard-setting agenda.

Nonetheless, the Committee observed that entities do not have an accounting policy choice
between applying IAS 12 and applying IAS 37 Provisions, Contingent Liabilities and
Contingent Assets to interest and penalties. Instead, if an entity considers a particular amount
payable or receivable for interest and penalties to be an income tax, then the entity applies
IAS 12 to that amount. If an entity does not apply IAS 12 to a particular amount payable or
receivable for interest and penalties, it applies IAS 37 to that amount. An entity discloses its
judgement in this respect applying paragraph 122 of IAS 1 Presentation of Financial
Statements if it is part of the entity’s judgements that had the most significant effect on the
amounts recognised in the financial statements.

Paragraph 79 of IAS 12 requires an entity to disclose the major components of tax expense
(income); for each class of provision, paragraphs 84⁠–⁠85 of IAS 37 require a reconciliation of
the carrying amount at the beginning and end of the reporting period as well as other
information. Accordingly, regardless of whether an entity applies IAS 12 or IAS 37 when
accounting for interest and penalties, the entity discloses information about those interest and
penalties if it is material.

(f) Disclosures

Please refer to Appendix B: Disclosure examples

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IAS 10 EVENTS AFTER THE REPORTING DATE

(a) Adjusting events

Events that provide additional information on the conditions that existed at the end of the
reporting period are included as adjustments to the amounts in the financial statements,
irrespective of whether the fact was actually known at the end of the reporting period.

Students should study and highlight the examples included in paragraph 9 of IAS 10
carefully. Paragraph 9(a) is important as it relates to the adjustment of an existing provision or
the recognition of a NEW provision for a previously disclosed contingent liability. Paragraph
9(b) also states if evidence of a trade debtor that was insolvent at the end of the reporting
period is only received after the reporting period, this is an adjusting event. This would
require impairment of the trade debtor at the end of the reporting period.

(b) Dividends

❑ If dividends to holders of equity instruments (as defined in Standard IAS 32 Financial

Instruments: Presentation) are declared after the reporting date, an entity should not
recognise those dividends as a liability at the reporting date. This is due to the absence
of a present obligation due to a past obligating event at the reporting date. The dividend
declaration will be the past obligating event. Note that in terms of the avoidance test,
the entity can avoid the payment of the dividend until the declaration of such dividend.
No constructive obligation arises for the dividend either until the declaration of the
dividend.

❑ The disclosure must be made in the notes to the financial statements in accordance with
IAS 1 Presentation of Financial Statements.

The Standard determines that the dividend declaration date should be the obligating event that
gives rise to the shareholders for dividend liability. The date that a dividend is proposed
should therefore not be a consideration anymore. Also note that the company will however
have a legal present obligation at reporting date to declare a dividend should there be a
shareholders’ agreement stipulating an annual dividend. Then a liability may be raised at the
reporting date.

(c) Going concern

❑ An entity should not prepare its financial statements on a going concern basis if
management determines after the reporting date that it intends to liquidate the entity or
to cease trading, or that it has no realistic alternative but to do so.

❑ Disclosure is required if:

● the financial statements are not prepared on a going concern basis; or

● management is aware of material uncertainties related to events or conditions that
may cast significant doubt upon the entity’s ability to continue as a going concern.
The events or conditions requiring disclosure may arise after the reporting date.
 - 17 -
E. ILLUSTRATIVE EXAMPLES

Example 1

A manufacturer offers a warranty at the time of sale of a product to the purchaser of its
product. Under the terms of the contract of sale, the manufacturer undertakes to make good,
by repair or replacement, any manufacturing defects that become apparent within three years
from the date of sale of such a product. On past experience, it is probable (i.e. more likely
than not) that there will be claims in terms of the warranties provided.

Use the principles of IAS 37 to discuss the above scenario – i.e. focus on the credit leg,
being the “provision for warranty costs” and justify this leg.

- Please refer to Part B Illustrative example: Example 1 Warranties

Example 2

An enterprise operates an offshore oilfield where its licensing agreement requires it to remove
the oil rig at the end of the production and restore the seabed. Ninety per cent of the eventual
costs relate to the removal of the oil rig and restoration of damage caused by building it, and
ten per cent arises through the extraction of oil. At the first reporting date, the rig has been
constructed but no oil has yet been extracted.

Discuss in terms of IAS 37 the proposed accounting recognition and measurement of the
above scenario in the accounting records of the enterprise at the first reporting date.

- Please refer to Part B Illustrative example: Example 3 Offshore oilfield

Example 3 – Staff retraining as a result of changes in the income tax system

The government introduced a number of changes to the income tax system. As a result of
these changes, an enterprise in the financial services sector will need to retrain a large
proportion of its administrative and sales workforce in order to ensure continued compliance
with financial services’ regulations. At the reporting date, no physical retraining of staff has
taken place.

Discuss in terms of IAS 37 the proposed accounting recognition and measurement of the
above scenario in the accounting records of the enterprise at the reporting date.

- Please refer to Part B Illustrative example: Example 7 Staff retraining as as result

of change in the income tax system

Example 4 – An onerous contract

An enterprise leases a machine that is determined to be a low value item. The lease is
therefore exempt from the default treatment in IFRS 16 Leases and accounted for as an
expense in profit/loss, straight lined over the lease term. During December 2024, the
enterprise changed its production methods and no longer required the leased machine in its
production process due to new and improved technology that had subsequently become
available. The lease of the old machine continues for the next four years (i.e. until
31 December 2028) at R800 per month and cannot be cancelled. The machine has been sublet
to another lessee under an operating lease at R600 per month. An appropriate rate of interest
 - 18 -
for similar transactions is 12% per annum, nominal and pre-tax.

Discuss in terms of IAS 37 the proposed accounting recognition and measurement of the
above scenario in the accounting records of the enterprise at the reporting date (i.e.
31 December 2024). Assume the entity has early adopted IFRS 16 Leases.

Example 5 – Events after the reporting date

On 15 January 2024, A Ltd discovered for the first time that one of its material receivables
was experiencing financial problems. From discussions with the attorneys of the receivable,
it became clear that the receivable had already been experiencing financial problems since the
beginning of 2023. The receivable was however only physically declared insolvent by the
lawyers on 15 February 2024. Therefore, on this date it became clear that the trade receivable
will be unable to settle the debt.

The financial reporting period of A Ltd is 31 December. The financial statements of A Ltd
are usually authorised for issue on 31 March of the next financial reporting period.

Discuss in terms of IAS 37 and/or IAS 10 the proposed accounting treatment of the
above scenario in the accounting records of the enterprise at the first reporting date.

- Please refer to Part B Illustrative example: Example 5A and 5B Closure of division

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SUGGESTED SOLUTIONS TO ILLUSTRATIVE EXAMPLES

Example 1 (Suggested solution)

Should a provision be recognised for warranty costs at the date of sale of the product?

1. Present obligation – a legal present obligation exists in terms of the sales contract to provide a
warranty as from the date of sale of the product. This cannot be avoided by the enterprise
(IAS 37.19) and it therefore has no realistic alternative than to settle any claims on the
warranty contract. The present obligation is that the seller of the underlying asset in the
warranty contract guarantees the underlying product to be free from latent defects as at the
date of sale of the product.

2. Past obligating event – the entering into a sales contract (including a warranty contract)
between the seller and buyer where the contract guarantees the underlying asset to be free
from latent defects as at the date of sale. This event effectively created the present obligation
for the enterprise to provide the warranty service. This event occurred before the reporting
date and is therefore a past event.

3. Probability of future benefit outflows – from the past experience of the enterprise, this seems
to be probable (i.e. “more likely than not”).

4. Reliable measurement of the amount - can a reliable value be placed on such an outflow?
- base measurement on the reliable past experience of the enterprise;
- if amount cannot be reliably measured, no provision can be made.

5. Avoidance test (IAS 37.19) – the entity cannot avoid the obligation arising in terms of the
warranty contract by ceasing future activity (i.e. closing their business). The entity therefore
already has a present obligation at transaction date as that was when the underlying asset’s
condition was guaranteed to meet certain requirements. The entity has no realistic alternative
but to settle the obligation (i.e. a present obligation).

A provision should be recognised at the date of the sale of the product.

Example 2 (Suggested solution)

Identification: Should a provision be recognised for restoration costs? What is the timing of such a
provision? Should the provision be discounted as financing is effectively supplied to the enterprise
in the transaction?

1. Present obligation – a legal present obligation exists because of the licence agreement. In
South Africa, legislation exists governing such restoration of damage to the environment. The
entity can therefore not avoid settling the cost of restoring any damages done to the
environment and is presently obligated, but only where such damages have already been
done. The only obligation that can be avoided is the cost of restoring the damages that have
not been done (i.e. the future damage) as at reporting date. This damage can still be avoided
by ceasing activities and therefore the entity has no present obligation in respect of future
damages. Read IAS 37.19 carefully in this regard.

2. Past obligating event – The damage done to the environment during the construction of the rig
(the action creating the liability has therefore taken place). The moment the entity damages
the environment, they incur an obligation to restore the environment. This event will be a past
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event in respect of all damages done to the environment before or at the reporting date.
Damages done after the reporting date will be regarded events after the reporting date.

3. Probability of future benefit outflows – yes it would be probable because of the agreement
and the legislation that governs the restoration of such damage to the environment (i.e. “more
likely than not”).

4. Reliable measurement of the amount - can a reliable estimate be made of the restoration costs?
If not, a provision cannot be recognised but only a contingent liability can be disclosed
(remember that uncertainty may exist surrounding the amount in terms of the definition of a
provision, but the amount still has to be at least reliably estimated for measurement purposes).

If reliably measurable/estimable, provide for the present value of 90% of the restoration costs
at the date that the damage is done. The rest of the damage can be avoided by ceasing activity
and therefore no present obligation exists in respect thereof.

5. Avoidance test (IAS 37.19) – the entity cannot avoid the obligation to restore the damages
that have already been done. It can however avoid any further damages by ceasing future
activities as at the reporting date. There is therefore only a present obligation in respect of
restoring damages already done (i.e. the entity has no realistic alternative but to settle the
damages that have already been done by means of restoration of the environment).

6. Conclusion: (Remember to always write down an appropriate conclusion, this is good exam
technique).

Example 3 (Suggested solution)

Identification: Should a provision be recognised for staff retraining costs?

1. Present obligation – there is no legal/constructive obligation to date to pay the retraining costs
as the retraining of the staff has not yet begun. It is important here to note that there is an
obligation on the company to have their staff retrained by means of an act that was introduced.
THE EXISTENCE OF AN ACT OR CONTRACT DOES NOT IN ITSELF CREATE A
PRESENT OBLIGATION. It is possible for the company to avoid such retraining costs by
for example changing their activities in which case they will not be liable to have their staff
retrained at all. You must therefore be careful of laws that have been enacted in the country or
even contracts that have been entered into – these laws/contracts do not necessarily create a
present obligation on the company to incur any costs! Always perform the avoidance test in
terms of IAS 37.19 to determine present obligation.

2. Past obligating event – this event would be the physical retraining of the staff. There is no
event as yet that creates a present obligation for the enterprise. Should the staff have been
retrained by reporting date, the company would have had an obligation (i.e. a creditor to pay
for the retraining activities that had been done up to reporting date). Should the staff not have
been retrained by reporting date and the company ceases business activities, they will not have
to pay for any retraining of their staff!

3. Probability of future benefit outflows – such an outflow is probable as the company will not
comply with financial services’ regulations if staff is not retrained (i.e. “more likely than not”
that staff will be retrained).

4. Reliable measurement of the amount - cost incurred, not necessarily paid.

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As there is no present obligation, no provision may be recognised for such retraining of staff.
The amount may however be reliably measurable (or estimable) but that fact is neither
mentioned in the information nor relevant in this scenario.

5. Avoidance test (IAS 37.19) – the company can avoid the costs of retraining staff by, for
example, ceasing its future activities or changing its future activities. There is therefore no
present obligation to retrain staff as the company has a realistic alternative to settling the
retraining costs – this would be not to have the staff members retrained!

Example 4 (Suggested solution)

Identification: Should a provision be recognised for the onerous contract? The lease of the
machine qualifies as an onerous contract since it is a contract in which the unavoidable costs of
meeting the obligation (i.e. the lease instalments of R800 per month) under the contract exceed the
economic benefits expected to be received under the contract (i.e. R600 monthly future instalments
as the property has been relet).

1. Present obligation – The present obligation arises due to the transfer of the risk of the contract
at the date at which the lease of the low value machine becomes onerous, i.e. the fact that
costs are not recoverable in full in terms of the contract. Due to the low value lease exemption
applied in IFRS 16, no right of use asset or lease liability was recognised at inception of the
lease. The significant risk of an onerous contract is the non-recoverability of costs to which
the entity has committed. This risk is therefore transferred to the lessee at the stage when the
lease contract becomes onerous.

2. Past obligating event – the lease contract becoming onerous. This exposed the enterprise to
the risk of non-recoverability of the costs of the contract. This event took place before the
reporting date, when the entity improved its production process and no longer had a use for
the machine.

3. Probability of future benefit outflows – the entity assessed the lease contract as onerous. The
outflow of benefits in the form of costs that the company are contractually committed to R800
per month for the remaining lease term (which exceed the benefits receivable from the
contract of R600 for the remaining lease term) is therefore probable (i.e. “more likely than
not”) to occur.

4. Reliable measurement of the amount - Fixed instalments under lease contracts (at present
value) less expected income from sublease.

Thus a provision must be provided for in terms of the onerous contract.

5. Avoidance test (IAS 37.19) – the company cannot avoid the excess costs of R200 per month
(i.e. R800 – R600) even by ceasing production. A present obligation therefore exists for the
non-recoverable (net) costs at reporting date.
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The journal entries will be as follows for an onerous contract:

31 December 2024

Dr Loss on onerous contract (P/L) 7 595

Cr Provision for onerous contract (F/P) 7 595
(Recognise provision for onerous contract)
(FV = 0; PMT = R200 (i.e. R800 – R600); I/Yr = 12%; P/Yr = 12; N = 48)

31 December 2025

Dr Lease expense (P/L) (800 x 12) 9 600

Cr Bank 9 600
(Pay lease instalment on building)

Dr Bank (600 x 12) 7 200

Cr Lease income (P/L) 7 200
(Receive lease instalment on building)

Dr Interest expense (P/L) 827

Cr Provision for onerous contract (F/P) 827
(Raise interest on obligation) (1 INPUT 12 Shift Amort)

Dr Provision for onerous contract (F/P) 2 400

Cr Lease expense (P/L) 2 400
(Reverse excess lease expense already provided 31/12/2019)
(R800 – R600) x 12

The above is repeated for the remainder of the lease until 2028.

Example 5 (Suggested solution)

Identification: Should an adjustment be made for an event after the reporting date (the discovery of
the financial problems of the receivable) in the financial statements at the reporting date?

1. The issue is whether the receivable had been insolvent already at the reporting date and not
able to pay his debt at that stage – that fact would represent a “condition” surrounding the
receivable at the reporting date. The discovery of the doubtful debt problem was made after
the reporting date and therefore represents an event after the reporting date which is dealt with
in terms of IAS 10.

2. The receivable had already experienced financial problems since 2023. Thus the condition
(impairment of the receivable) had already existed at the reporting date in respect of the
receivable (asset). (IAS 10 par.9(b)(i))

The enterprise should therefore adjust the carrying amount of the receivable with the amount
expected not to be recovered (i.e. impaired). This is not a “provision” as envisaged by IAS 37
Provisions, Contingent Liabilities and Contingent Assets as there is no present obligation, but
rather represents a valuation allowance in respect of the impaired receivable. The valuation
adjustment is made in respect of the reduction of future benefits expected from the asset (i.e.
the receivable).
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Journal entry (only for completeness’ sake)

Dr Impairment loss (P/L) XX

Cr Receivables (F/P) XX

Note: If there had been uncertainty about whether the receiable would pay or not, there would be a
significant increase in credit risk (Stage 2), therefore, an expected credit loss allowance
should be recognised (IFRS 9) but because the receivable has been physically declared
insolvent making it a credit default (Stage 3), the receivable is derecognised by actually
crediting the receivables directly.
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F. ILLUSTRATIVE DISCLOSURES: IAS 37

- Please refer to Part B Illustrative example: Example 1 Warranties

- Please refer to Part B Illustrative example: Example 2 Discommissioning costs
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ILLUSTRATIVE DISCLOSURES: IAS 10