L10 - MFRS 137
L10 - MFRS 137
L10 - MFRS 137
PROVISIONS, CONTINGENT
LIABILITIES AND
CONTINGENT ASSETS
Learning Objectives
Definition and accounting treatment on
provisions, contingent liabilities and contingent
assets.
Legal obligation
Derives from a contract, legislations or other
operation of law.
Example: Obligation to replace the defective
parts for car sold as stated in the sales
agreement.
Example:
By practice, the company pays two months bonus to its current
employees even though there is no contract to do so.
A logging company by practice plants new trees after it has logged a
certain area though there is no legal requirement to do so.
PROVISIONS : Present Obligation
Illustration 137.2
ABC Bhd is an oil exploratory company. It operates in a country
where there is no environmental legislation. However, the
company has a widely published environmental policy in
which it undertakes to clean up all contamination that it
causes. The enterprise has a record of honouring this
published policy.
Constructive Obligation
A management or board decision does not
give rise to a constructive obligation at the
balance sheet date unless the decision has
been communicated before the balance
sheet date to those affected by it in a
sufficiently specific manner to raise a valid
expectation in them that the enterprise will
discharge its responsibilities.
PROVISIONS : Present Obligation
Illustration 137.3
On 12 Dec 20x2, the Board of XYZ Bhd decided to
close down a division.
Before the balance sheet date (31 Dec 20x2), the
decision was not communicated to any of those
affected and no other steps were taken to implement
the decision.
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PROVISIONS
Example
Future operating losses
The manufacturing plant of ABC Bhd has been incurring losses in the past
three years. Management is contemplating the option of either to
restructure the plant or to sell it to an external party. Management
believes that losses will continue for another two years at about RM30
million per year before the business operation could turnaround. At year
end, neither the restructuring plan nor the plan to sell was finalised. The
carrying amount of the net assets of the plant at year end was RM400
million. Based on its current condition, the recoverable amount of the
plant was estimated at RM350 million.
Required
Explain the accounting treatment that shall be accorded to the above
case.
PROVISIONS
Solution
Future operating losses
Notwithstanding that the operations of the plant may be restructured or
that it may be sold to an external party, the estimated future losses of
RM60 million shall not be recognised as a liability because there is no
present obligation at the end of the reporting period, ie. There is no
obligating event.
However, based on the impairment test performed, the plant shall be
written down to its recoverable amount of RM350 million and the
impairment loss of RM50 million recognised as an expense in the current
year’s profit or loss.
Carrying amount = RM400 million Choose lower
RM350 million
Recoverable amount = RM350 million
Carrying amount to reduce to RM350 million
Impairment loss = RM400 million – RM350 mil = RM50 mil
PROVISIONS - Onerous contract
An onerous contract is one 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 cost of fulfilling the contract and
penalties/compensation as failure to fulfill contract.
If an entity has a contract that is onerous, a provision should
be recognised for the present obligation under the contract
based on the unavoidable costs.
However, before provision is recognised, the standard requires
an entity to recognise any impairment losses for any dedicated
assets to the contract.
PROVISIONS- Onerous contract
Illustration 137.10
PQR Bhd operates profitable from a factory that it has leased under an
operating lease. During Dec 20x2 the enterprise relocates its operations
to a new factory. The lease on the old factory continues for the next four
years, it cannot be cancelled and the factory cannot be re-let to another
user.
Division B
The closure cost is estimated at RM400,000. A detailed plan
for the closing down has been agreed upon by the Board on
15 Dec x5 and redundancy notices were sent to the staff.
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DISCLOSURE - Provision
For each class of provision, an entity shall disclose:
a.the carrying amount at the beginning and end of the period;
b.additional provisions made in the period, including increases
to existing provisions;
c.amounts used (ie incurred and charged against the provision)
during the period;
d.unused amounts reversed during the period; and
e.the increase during the period in the discounted amount
arising from the passage of time and the effect of any change in
the discount rate.
Comparative figure is not required.
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DISCLOSURE - Provision
Example
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CONTINGENCIES
Events or outcome which is determined by
other events whose outcomes are uncertain.
Classified into:
- Contingent liability;
- Contingent asset
CONTINGENT LIABILITIES
MFRS 137 defined Contingent Liability as:
A possible obligation that arises 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 enterprise; or
A present obligation that arises from past events but is not
recognised because:
1. it is not probable that an outflow of resources embodying
economic benefits will be required to settle the
obligation;
2. the amount of the obligation cannot be measured with
sufficient reliability.
CONTINGENT LIABILITIES
Contingent liabilities in MFRS137 is restricted to possible obligations and
obligations for which it is not probable that an outflow of resources
embodying economic benefits will occur, or for which the amount cannot be
estimated reliably.
Contingent liabilities should not be recognised.
Contingent liabilities should be disclosed in the notes to accounts, unless the
possibility of outflow of resources embodying economic benefits is remote.
If it becomes probable that an outflow of future economic benefits will be
required for an item previously dealt with as a contingent liability, a
provision is recognised in the financial statements of the period in which the
change in probability occurs (except in the extremely rare circumstances
where no reliable estimate can be made).
Provision vs Contingent Liability
• A provision is a type of liability ie a present obligation exists and
it is probable that economic benefit will flow from the entity.
The liability however is of uncertain timing or amount.
By contrast a contingent liability can arise in three situation:
• Where a possible obligation exists (as opposed to a probable
obligation)
• Where there is a present obligation but it is not recognised as it
is not probable that economic benefit will flow from the entity
(with a provision outflow is probable)
• Where there is a present obligation but the obligation cannot
be measured with sufficient reliability (with a provision the
amount may be uncertain but is capable of reliable estimation)
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CONTINGENT LIABILITIES - Recognition
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.
Remote
Ignore
Entity has to determine by judgement if a contingency is a
probable or possible or remote.
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CONTINGENT LIABILITIES
Probable contingent liability
A contingent liability that is probable is considered a liability.
If the amount can be estimated reliably it should be accounted for.
If the amount cannot be estimated reliably, then a disclosure by way
note is to be made.
Possible contingent liability
Possible contingent liability should not be recognised.
A disclosure is made in the financial statement by way of a note if a
contingent liability is possible but not remote.
Remote contingent liability
If the contingent liability is remote it need not be disclosed.
Disclosure –
CONTINGENT LIABILITIES
MFRS 137 requires disclosures of the following
information;
• a brief description of the nature of the
contingent liability;
• an estimate of its financial effect,
• an indication of the uncertainties relating to the
amount or timing of any outflow, and
• the possibility of any reimbursement.
CONTINGENT LIABILITIES
Example of disclosures of contingent liability;
32 Contingent Liability
Company
20X4 20X3
RM RM
Corporate guarantee given to banks
for credit facilities granted to
subsidiaries (unsecured) 64,843,200 71,904,200
PROVISION vs CONTINGENT LIABILITIES
Generally, all provisions are contingent liabilities as there
is uncertainty about the timing and amount.
However, MFRS 137 uses the term ‘provision’ to cover
contingencies that are recognised as liabilities in the
statement of financial position.
The term ‘contingent’ is used for liabilities and assets that
are not recognised either because their likelihood of
crystallisation is only possible or remote, or because they
fail the recognition criteria such as reliable estimate of the
amount cannot be made.
PROVISION vs CONTINGENT LIABILITIES
Example 3 of textbook
An employee was injured while carrying out his job function.
He has taken legal action and the outcome is uncertain.
In this case the entity has to determine if it has a liability.
There is a past event but the obligation is uncertain.
If there is a probability that the entity will be held liable, then
there is an obligation. The entity has to make a reliable
estimate of the cost to be incurred.
Assuming it is able to estimate reliably the cost, then the
entity has a liability and has to accrue it.
If the entity is unable to estimate the cost then it has to make
a disclosure of the fact.
CONTINGENT ASSETS
MFRS 137 defines Contingent Assets as:
A possible asset that arises 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 enterprise.
MFRS 137 provides that contingent assets
should not be recognized .
should be disclosed where it is probable that the gain will be realised
or where inflow of economic benefits is probable .
gain contingencies which are possible or remote shall not be
disclosed.
This requirement is basically an application of the prudence
consideration because a contingent asset may result in the
recognition of income which may never be realised.
Gain Contingencies
With the provisions of MFRS137 and also the
conservatism principle, contingent assets are seldom
disclosed in financial statements.
As a general rule, we
never record GAIN
contingencies.
CONTINGENT ASSETS
In rare circumstance where the realisation of a contingent gain
is virtually certain, then such gain is not a contingency and its
recognition of the asset is appropriate.
Example
A legal suit filed against a third party has been ruled in favour
of the entity and the decision is known before the financial
statements are authorised for issue.
In this case, the amount recoverable from the third party shall
be recognised because the gain is no longer a contingency.
CONTINGENT ASSETS
Example 4 of textbook
In Nov x3, a poultry farmer had to destroy all his poultry due to
a government order to contain the spread of the avian flu. On 15
Dec x3, the government made a press statement stating that it
would pay compensation to all poultry farmers.
On 10 July x4, the farmer received a letter specifying the amount
he would received.
Can the farmer recognise an asset in x3?
34 Contingent Assets
Group Company
20X4 20X3 20X4 20X3
RM’000 RM’000 RM’000 RM’000
Differences between the amount
claimed and the amount awarded
by the Government in respect of the
land acquired or utilised by the
Government 1,590 3,184 1,483 -
Tutorial Question
Questions from Jane Lazar & Huang Ching
Choo. 2014. Financial Reporting Standards for
Malaysia. 4th Edition – Chapter 38
•Question 3
•Question 4
•Question 5
•Question 6
70
Lecture
Exercise
Questions
1. ABC is the plaintiff in a RM16 million lawsuit filed against a supplier. The
litigation is in final appeal and legal counsel advises that it is virtually
certain that ABC will win the law wuit and be awarded RM12 million. How
should ABC account for this event?
2. DEF can estimate the amount of loss that will occur if a foreign government
expropriates some company property. Expropriation is considered
reasonably possible. How should DEF report this loss?
3. XYZ manufactures kitchen storage products. During the year, the company
became aware of potential costs due to
a. a possible product defect that is reasonably possible and can be
reasonably estimated,
b. A safety hazard that is probable and cannot be reasonably estimated
c. A new product warranty that is probable and can be reasonably
estimated.
Which, if any, of these costs should be accrued?