ias 37 solutions pdf

IAS37Provisions,contingentliabilitiesandcontingentassets

Solutions

VroniqueWeets

IAS37Provisions,contingentliabilitiesandcontingentassetsSolutions

InstituutvandeBedrijfsrevisoren 227oktober2010

TABLE OF CONTENTTableofcontent......................................................................................................................................................2

Definitions...........................................................................................................................................................3

Measurement....................................................................................................................................................10

Bestestimate.................................................................................................................................................10

Discountrate.................................................................................................................................................11

Effectofreimbursements..............................................................................................................................12

Generalcases.................................................................................................................................................13

Onerouscontracts.............................................................................................................................................15

Restructurings...................................................................................................................................................18

Recognitionofarestructuringprovision.......................................................................................................18

Costofrestructuring......................................................................................................................................19

IFRIC1Changesinexistingdecommissioning,restorationandsimilarliabilities...........................................21

Financialguaranteecontracts...........................................................................................................................25

IFRIC13Customerloyaltyprogrammes.........................................................................................................26

ED2010/1MeasurementofliabilitiesinIAS37................................................................................................27

IAS37Provisions,contingentliabilitiesandcontingentassetsDefinitions


DEFINITIONS

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1. Identifywhethereachofthefollowingwouldbealiability,aprovisionoracontingentliability,ornoneoftheabove,inthefinancialstatementsofcompanyAasatitsbalancedateof30June20X5.AssumethatcompanyAsfinancialstatementsareauthorizedforissueon24August20X5(Alfredsone.a.,pg190,exercise5.7)

a. Anamountof35000owingtocompanyZforservicesrenderedduringMay20X5.

Liability

b. Longserviceleave,estimatedtobe500000,owingtoemployeesinrespectofpastservices.

Provisionamountandtimingareuncertain

c. Costsof26000estimatedtobeincurredforrelocatingemployeeDfromcompanyAsheadofficelocationtoanothercity.ThestaffwillphysicallyrelocateduringJuly20X5.

Noprovisionorliabilitytheamountisafuturecost.

d. Provisionof50000fortheoverhaulofamachine.Theoverhaulisneededevery5yearsandthemachinewasfiveyearsoldasat30June20X5.

NoprovisionorliabilitynopresentobligationtooverhaulthemachineCompanyAcoulddecidetosellthemachineornotrepairit.

e. DamagesawardedagainstCompanyAresultingfromacourtcasedecidedon26June20X5.Thejudgehasannouncedthattheamountofdamageswillbesetatafuturedate,expectedtobeinSeptember20X5.CompanyAhasreceivedadvicefromitslawyersthattheamountofthedamagescouldbeanythingbetween20000and7million.

Thisisapresentobligationandtheobligatingeventhasoccurred,thereforeitisaliability;howevertheamountcannotbereliablymeasuredastheestimatedrangeistoogreat.Thereforethisshouldbedisclosedasacontingentliability,beingaliabilitythatfailstherecognitioncriterionofreliablemeasurement.



2. Acompanyhasequipmentforwhichtheenginerequirestobereplacedeveryfiveyears.

Determinewhetheraprovisionshouldberecognized.

Priortothecompanyincurringtheexpenditure,noprovisioncanbemadeforreplacementoftheengine,becausethecompanyhasnopresentobligationasitdoesnothavetoreplacetheengine.Forexample,itcouldavoidtheobligationbyshuttingdowntheequipment.Thisconclusionisconfirmedbyusingthesimpleyearendtest:ifthecompanydidnotcontinuetotradebeyondtheendof(say)yearthree,therewouldbenoneedtoincurthefutureexpenditureontheengine.Butalthoughnoprovisioncanbebuiltupoverthefiveyearsbeforetheexpenditureisduetobeincurred,theengineshouldbeseparatelyidentifiedanddepreciatedoverthatperiod.Whentheexpenditureisincurredtoreplacetheenginethiswillbecapitalizedaspartofthecostoftheequipmentanddepreciatedovertheperioduntilitisnextreplaced,thusavoidinganydoublecountingintheincomestatement.Thecostanddepreciationattributedtotheequipmentoriginallyshouldberemovedfromthestatementoffinancialpositiononcethecostofthenewenginehasbeencapitalizedtoavoiddoublecountinginthestatementoffinancialposition.

3. Acompanyleasesashipunderafinanceleasefor25years.Inordertobeseaworthyithastoobtainacertificateofseaworthiness,whichentailstheentitycarryingoutsignificantmaintenanceandoverhaulworkinadrydockeveryfiveyears.Withoutsuchacertificatetheshipcannotoperate.Thismatterisreferredtointhefinanceleaseagreement,whichrequirestheshiptobemaintainedinaseaworthycondition.


Althoughtheshipcannotcontinuetooperatewithoutacertificateofseaworthiness,thisinitselfdoesnotobligatethecompanytocarryouttherequiredmaintenancework.Itcouldinsteaddecidetolayuptheshipandnotcontinueitsoperation.Thetermsoftheleasewouldhavetobecarefullyscrutinizedtoensuretherewerenoclausesthatcouldchangethisconclusion,forexampleterminationclausesmightcreateanobligation.Wherenoobligationiscreatedbythelease,noprovisioncanbemadeforthesecosts.However,iftheelementoftheassetthatwearsoutcanbeidentifiedattheoutset,thiscostshouldbeamortizedoverthefiveyearterminthesamewayasiftheassetwereanownedasset.Whenthemaintenanceworkiscarriedout,thismaybecapitalizedifitrestorestheshipseconomicbenefits.



4. Acompanyiscurrentlyatenantofapropertyandisduetovacateitinfiveyearstime.Thereisaclauseinthetenancyrelatingtodilapidationworkwhichmustbeundertakenbeforethepropertyisvacated.Inaddition,thereisalsoaclausewhichenablesthelandlordtorechargethetenantforcostsrelatedtorepairingthefabricofthebuilding.Inthisregard,thelandlordisintendingtoreplacethecladdingonthebuildingandisobtainingquotesforthiswork.


Provisionshouldbemadefortheestimatedcostsofthedilapidationrepairsspreadovertheperiodofthetenancyforthefollowingreasons:

Thetenanthasapresentlegalobligation,arisingfromtheleaseagreement Theobligatingeventisthewearandteartotheproperty,whicharisesovertheperiodofthetenancy

anditsrepaircanbelegallyenforced Becausetheobligationarisesfromthewearandteartotheproperty,itisnotrelatedtofuture

operatingcosts Itisalmostcertainthattheobligationwillresultinanoutflowofeconomicbenefits Itispossibletomakeareliableestimateoftheyearlyobligationarisingfromtheextentofthewear

andteartakingplaceeachyear.Thiswillnotnecessarilyequatetoonefifthoftheestimatedtotal.

Withregardtorepairingthefabricofthebuilding,itshouldbeclearfromtheleasewhetherornotanobligationarises.Ifdamagehasalreadybeendonetothepropertythenaprovisionshouldbemadeforthewholeoftherectificationworkwhenthedamageisidentified.

5. Anenterpriseintheoilindustrycausescontaminationbutcleansuponlywhenrequiredtodosounderthelawsoftheparticularcountryinwhichitoperates.Onecountryinwhichitoperateshashadnolegislationrequiringcleaningup,andtheenterprisehasbeencontaminatinglandinthatcountryforseveralyears.At31December2000itisvirtuallycertainthatadraftlawrequiringaleanupoflandalreadycontaminatedwillbeenactedshortlyaftertheyearend.


Theobligatingeventisthecontaminationofthelandbecauseofthevirtualcertaintyoflegislationrequiringcleaningup.Anoutflowofresourcesembodyingeconomicbenefitsinsettlementisprobable.Therefore,aprovisionisrecognizedforthebestestimateofthecostsofthecleanup(seeIAS37.14and.22).

6. Anenterpriseintheoilindustrycausescontaminationandoperatesinacountrywherethereisnoenvironmentallegislation.However,theenterprisehasawidelypublishedenvironmentalpolicyinwhichitundertakestocleanupallcontaminationthatitcauses.Theenterprisehasarecordofhonoringthispublishedpolicy.


Theobligatingeventisthecontaminationoftheland,whichgivesrisetoaconstructiveobligationbecausetheconductoftheenterprisehascreatedavalidexpectationonthepartofthoseaffectedbyitthattheenterprisewillcleanupcontamination.Anoutflowofresourcesembodyingeconomicbenefitsinsettlementisprobableandaprovisionisrecognizedforthebestestimateofthecostsofcleanup(seeIAS37.10(thedefinitionofaconstructiveobligation),.14and.17).



7. Aretailstorehasapolicyofrefundingpurchasesbydissatisfiedcustomers,eventhoughitisundernolegalobligationtodoso.Itspolicyofmakingrefundsisgenerallyknown.


Theobligatingeventisthesaleoftheproduct,whichgivesrisetoaconstructiveobligationbecausetheconductofthestorehascreatedavalidexpectationonthepartofitscustomersthatthestorewillrefundpurchases.Anoutflowofresourcesembodyingeconomicbenefitsinsettlementisprobable,sinceaproportionofgoodsarereturnedforrefund(seeparagraph24).Therefore,aprovisionisrecognizedforthebestestimateofthecostsofrefunds(seeparagraphs10(thedefinitionofaconstructiveobligation),14,17and24).

8. Undernewlegislation,anenterpriseisrequiredtofitsmokefilterstoitsfactoriesby30June20X0.Theenterprisehasnotfittedthesmokefilters.


a. Atthebalancesheetdateof31December20X1

Thereisnoobligationbecausethereisnoobligatingeventeitherforthecostsoffittingsmokefiltersorforfinesunderthelegislation.Noprovisionisrecognizedforthecostoffittingthesmokefilters(seeIAS37.14andIAS37.17to.19).

b. Atthebalancesheetdateof31December20X0

Thereisstillnoobligationforthecostsoffittingsmokefiltersbecausenoobligatingeventhasoccurred(thefittingofthefilters).However,anobligationmightarisetopayfinesorpenaltiesunderthelegislationbecausetheobligatingeventhasoccurred(thenoncompliantoperationofthefactory).Assessmentofprobabilityofincurringfinesandpenaltiesbynoncompliantoperationdependsonthedetailsofthelegislationandthestringencyoftheenforcementregime.Noprovisionisrecognizedforthecostsoffittingsmokefilters.However,aprovisionisrecognizedforthebestestimateofanyfinesandpenaltiesthataremorelikelythannottobeimposed(seeIAS37.14andIAS37.17to.19).

9. Healthandsafetylegislationhasbeenintroducedthatrequiresasbestostoberemovedfromallbuildings.Asbestosremovalisrequiredwhetherornotthepropertyisinuse.Thelegislationiseffectivefrom31December20X2.EntityAownsa20yearoldfactorythatincludesasbestos.TheestimatedcostofremovingtheasbestosisCU70000,plusafurtherCU30000inlostprofitsbecausethefactorywillnotbeabletooperateatfullcapacitywhiletheasbestosisbeingremoved.At31December20X2,theworkhasnotcommencedinrespectoftheasbestosremoval;however,contractshavebeensignedwithcontractorsfortheworktobeperformedinthefirstfewmonthsof20X3.


TheHealthandSafetylegislationhasbeenenactedandthereis,therefore,arequirementfortheasbestostoberemoved.Theobligating(past)eventisthecontaminationcausedbythepresenceoftheasbestosandtheexistenceofalegalrequirementtoremoveitcreatesanobligationthatshouldbeprovidedfor.Therefore,entityAshouldrecognizeaprovisionforCU70000,beingthecostofremovingtheasbestos.Noprovisionshouldbemadefortheoperatinglossesthatwillbeincurredduringtheperiodofasbestosremoval,becausethereisnoobligationtoincurtheselosses.Managementcouldattempttorescheduleorrelocateoperationstoavoidorminimizethelosses.Theoperatinglossesareanindirectresultoftherequirementtoremovetheasbestos.Theexistenceofsignedcontractsdoesnotaffecttheconclusionofwhethertoprovideforthecosts.Thecontractsareexecutorcontracts,sonoliabilitytothecontractorarisesuntilthecontractorperformsworkunderthecontract.



Theintroductionofthenewlawdoesnotcreatetheobligatingeventonitsown.Itisthecombinationofthepastcontaminationandthenewlawthatcreatestheobligationtoremovetheasbestos.Thiscanbecontrastedwiththesmokefiltersinthepreviousexamplewherethereisnopastcontaminationandsotheobligationcreatedwhenthelegislationcomesintoforceisonlyforpenaltiesandfines.10. Thegovernmentintroducesanumberofchangestotheincometaxsystem.Asaresultofthesechanges,anenterpriseinthefinancialservicessectorwillneedtoretrainalargeproportionofitsadministrativeandsalesworkforceinordertoensurecontinuedcompliancewithfinancialservicesregulation.Atthebalancesheetdate,noretrainingofstaffhastakenplace.


Thereisnoobligationbecausenoobligatingevent(retraining)hastakenplace.Noprovisionisrecognized(seeIAS37.14andIAS37.17to.19).

11. Acompanysellsgardeningmerchandise.Onsomeofitsproductsitwarrantsatthetimethesaleismadethatitwillmakegoodbyrepairorreplacementmanufacturingdefectsthatbecomeapparentwithinoneyearfromthedateofsale.Itspastexperienceshowsthatitdoesreceivewarrantyclaimsontheseproducts.


Aprovisionshouldbemadeforthebestestimateoftheobligationforthefollowingreasons: Alegalobligationexistswhichismorelikelythannottoarise Theobligatingeventisthesaleoftheproductandthenormaloneyearwarrantycanbelegally

enforced Therelatedcostsofrepairdonotrelatetothecompanysfutureoperations Frompastexperience,itismorelikelythannotthattheobligationwillresultinanoutflowofeconomic

benefits Areliableestimateoftheobligationcanbemadefromthecompanyspreviousclaimsexperience.

Usingthesimpleyearendtest,ifthecompanystoppedtradingatitsyearend,itwouldstillbeliablefortheobligationsarisingfromwarrantiesithasalreadygiven.Hence,provisionisrequired.

Wouldyouranswerchangeifthecompanymakesapaymenttoathirdpartyinsurer,whichunderwritestherisk.Intheeventofaclaimbyacustomer,thecompanywouldclaimacorrespondingamountfromtheinsurer.

Provisionwouldbemadeforthewarrantyforthereasonsgivenabove.Themereexistenceoftheunderwritingagreementdoesnotmeanthatthecompanycanignorethewarrantyobligation.Thecustomerhasrecoursedirectlytothecompanyforthewarranty.Thecompanyinturnhasaclaimontheinsurancecompany,butthisdoesnotoffsetthecompanysobligationtoitscustomer.Hencethecompanywillhavetoprovideforitsbestestimateofitswarrantyobligation.Itwillhavetoconsiderwhetherornotitcanrecognizeitscounterclaimonitsinsurer.Itcannotrecognizeaseparatedebtorforsuchclaims,unlessitisvirtuallycertainthatitwillrecoverthefundsfromtheinsurer.Ifitcannotbethiscertain,thenitshoulddisclosetheexistenceofthecontingentassetinthenotestoitsfinancialstatements.



12. Acompanysellsanadditiveforleadedpetrolengines,whichallowsthemtocomplywithnewemissionrequirements.Thecompanyhasheardfromtherepresentativesoftencustomerswhoclaimthatthecanistershaveburstopenonuseandtheadditivehasburnttheirhands.Theycontendthatthecanisterswerefaulty.Thecompanyisinsuredforsuchliabilitiesanddoesnotexpecttoloseanymoneyiftheclaimssucceed.


Thefirststageinestablishingwhetheraprovisionshouldbemadeistodeterminewhetherthereisapresentobligation.Thepasteventarisesfromthesaletothecustomerofthepotentiallyfaultygoods.Apresentobligationwillarisefromeitherthecompanybeingfoundresponsibleforthecanistersburstingorfromthecostsassociatedwithdefendingtheclaim,evenwherethecompanyisnotliable.Theprosecutionwillhavetoprovethatapresentobligationhasarisenfromthecanistersburstingandthatsomecompensationisthenpayable.Whereitisunclearwhetherthecompanyisliable,itwillbenecessaryforthecompanydefindingtheactiontodeterminewhetherthereisapresentobligationarisingfromthepasteventandthismightentailitsseekingexpertadvice.Intheexample;thecompanymightcontendthatthereisnothingwrongwiththecanistersandthecustomersdidnotfollowthecompanysinstructionleaflet,whichclearlyshowshowtoavoidthereportedproblem.Ifitismorelikelythannot(thatis,greaterthana50%chance)thatthecompanyisliableforthecanistersbursting,thereisapresentobligationforwhichprovisionshouldbemadeifitisprobablethatanoutflowofeconomicbenefitswillbenecessary.Whereacompanydoesnotbelievethereisacasetoanswer,provisionforsomecostsmightstillbejustifiedatthebalancesheetdate.Inthiscase,thepresentobligationarisesfromthedecisiontodefendtheactionandthebestestimateofthecoststhatwillbeincurredindoingthatshouldbeprovided.

IAS37Provisions,contingentliabilitiesandcontingentassetsMeasurement


MEASUREMENT

BEST ESTIMATE

Determinetheamountoftheprovisiontoberecognized

1. Anentityfacesasinglelegalclaim,witha40%likelihoodofsuccesswithnocost,anda60%likelihoodoffailurewithacostof1m.

Wheretheprovisionrelatestoasingleevent,orasmallnumberofevents,expectedvalueisnotavalidtechniquesincetheoutcomewillneverbeacostof600,000(60%x1m).Itwilleitherbenilor1m.IAS37.40statesthattheprovisionshouldrepresentwhicheveristhemostlikelyofthesetwooutcomes.Itthisexample,itismorelikelythatacostof1mwillresult,andthereforefullprovisionwouldbemade.Asageneralruleofthumb,wherethemostlikelyoutcomeisclosetoexpectedvalue,itwillbeappropriatetoprovidethemostlikelyoutcomesinceexpectedvalueprovidesevidenceoftheprobableoutflowofbenefits.

2. Anentityfaces100legalclaims,eachwitha40%likelihoodofsuccesswithnocost,anda60%likelihoodoffailurewithacostofeachclaimof1m.

Usingexpectedvalue,thestatisticallikelihoodisthat60%ofclaimswillresultinacostof1m,thustheprovisionshouldbe60%*100*1m=60m.

3. Anentityisrequiredtoreplaceamajorcomponentinanassetunderawarranty.Eachreplacementcosts1m.Fromexperience,thereisa30%chanceofasinglefailure,50%chanceoftwofailures,anda20%chanceofthreefailures.

Themostlikelyoutcomeistwofailures,costing2m.Theexpectedvalueis1.9m(30%*1m+50%*2m+20%*3m).Theexpectedvaluesupportstheprovisionforthemostlikelyoutcomeof2m.Asecondruleofthumb,impliedbyIAS37.40,isthatwheremostlikelyoutcomeandexpectedvaluearenotclosetogether,itwilloftenbeappropriatetoprovideforwhicheverpossibleoutcomeisnearesttotheexpectedvalue.

4. Anentityisrequiredtoreplaceamajorcomponentinanassetunderawarranty.Eachreplacementcosts1m.Fromexperience,thereisa40%chanceofasinglefailure,30%chanceoftwofailures,anda30%chanceofthreefailures.

Themostlikelyoutcomeisasinglefailure,costing1m.Theexpectedvalueis1.9m(40%x1m+30%*2m+30%*3m).Inthiscase,themostlikelyoutcomeof1mhasonlya40%probability.Thereisa60%probabilitythatthecostwillbehigher.Theoutcomeclosesttoexpectedvalueis2m,thatistwofailures.



DISCOUNT RATE

1. AcompanyhasestimatedthatitneedstopayCU1000(incurrentprices)attheendofeachofthenextthreeyearstosettleanobligation.Thecompanyhasestablishedthatthenominaldiscountrateis5.5,whichincludesanestimatedinflationof2.5%peryear.Calculatethepretaxcashflows,theposttaxcashflows,therealdiscountrateandtheamountoftheprovision.

Netpresentvalue CFYear1 CFYear2 CFYear3

CFincludinginflationof2.5%perannum

2887(PVatnominaldiscountrateof4.5%

1025 1051 1077

CFexcludinginflation2877(PVatrealdiscountrateof1.95%)

1000 1000 1000

IRR(2887;1000;1000;1000)=1.95%or((1+4.5%)/(1+2.5%))1=1.95%2. On1January20X0,theBelgiangovernmentissuesabondforconsiderationof90,transactioncostsare5.Nominalvalueofthebondis110,nominalinterestrateis3.63%.Theinterestof4p.a.isreceivableoverthenext5years(31December20X0to31December20X4).Thebondhasamandatoryredemptionof110on31December20X4.

Calculatetheyieldinterestrateforthisbondandgivetheappropriateaccountingentriesforacompanythatacquiredthisbond.

IRR(95,4,4,4,4,114)=6,96%

CA(1/1) interest cashflow CA(31/12)20X0 95.00 6.61 4.00 97.6120X1 97.61 6.79 4.00 100.4020X2 100.40 6.99 4.00 103.3920X3 103.39 7.19 4.00 106.5820X4 106.58 7.42 114.00 0.00

1/1/20X0

Dr FinancialassetBond 95Cr Cash 95

31/12/20X0

Dr Cash 4Dr FinancialassetBond 2.61Cr Interestrevenue 6.61

31/12/20X1

Dr Cash 4Dr FinancialassetBond 2.79Cr Interestrevenue 6.79



31/12/20X4

Dr Cash 4Dr FinancialassetBond 3.42Cr Interestrevenue 7.42Dr Cash 110Cr FinancialassetBond 110

EFFECT OF REIMBURSEMENTS

1. Acompanysellsvacuumcleanersonwhichitgivesthestandardwarrantyofoneyearforpartsandlabor.Inadditionaspartofashorttermmarketingcampaignitgivesafurtherfouryearwarranty.Theextendedriskisthenunderwrittenbyaninsurancecompany.Thecompanyspastexperienceshowsthatinthelastyear70%ofthevacuumcleanerssoldwillnotbesubjecttowarrantyclaimsinthefirstyear.25%willhaveminordefectsand5%willrequirereplacementormajorwork.Inthesecondtofifthyears.experiencetodateshowsthat25%ofthosetakingouttheextendedwarrantywillrequireminorworkand10%willrequiremajorwork.100000unitsweresoldintheyearand10000customersweregivenextendedwarranty.MajorrepairorreplacingtheunitcostsapproximatelyCH25.MinorrepairscostCU5each(PWC.pg21032).

Theexpectedvalueofthestandardoneyearwarrantyis:70%*nil+25%*500000+5%*2500000=CU250000.Theexpectedvalueoftheextendedwarrantyclaimsis:65%*nil+25%*50000+10%*250000=CU37500.Clearly,itwouldbeappropriateforthecompanytomakeaprovisionforthefirstyearwarrantyattheexpectedvalueofCU250000whichrepresentsthebestestimateoftheobligation.Butalso,becauseIAS37requiresprovisioningtoeffectivelybemadegrossitmaybenecessaryforthecompanytoprovidefortheextendedwarrantyobligationofCU37500.Whetherornotthisamountistobeprovidedwilldependonthearrangementwiththeinsurancecompanyunderwritingthetransaction.Ifthecustomersrecourseistotheinsurancecompanyandthereisnofurthercomebackonthecompanyexcept;forexample,thattheinsurancecompanypaysthecompanytoundertaketherepairsthenthecompanywillnotberequiredtosetupaprovisionfortheextendedwarranty.Butwherethecustomerhasredresstothecompanyandinturnthecompanymakesacounterclaimagainsttheinsurancecompanyanobligationarisesonthecompanyforwhichprovisionmustbemade.Whetherornotthecompanycanthenrecognizetherecoveryfromtheinsurancecompanywilldependonthelikelysuccessofitsclaim.Iftherecoveryisvirtuallycertainthenanassetcanberecognized.Whererecoveryisnotvirtuallycertainthanallthecompanycandoisnotacontingentassetinitsfinancialstatements.



GENERAL CASES

1. Acompanyhasenteredintoanoperatingleaseforawarehouse.Thecompanywishestousethewarehouseforofficeaccommodation.IthasplanningpermissiontospendCU1.5monbuildingamezzaninefloorandbuildingpartitioningforoffices.Theoperatingleaseisforaperiodof15yearsandthepropertymustbereturnedtothelessorinitsoriginalconditionasthisisclearlyspecifiedinthecontract.ThecompanyestimatesthatitwillcostCU500000intodayscurrencytoremovetheimprovements.

Howshouldthecompanyaccountfortheseimprovements?

ThecompanyshouldcapitalizeleaseholdimprovementsofCU1.5mandamortizethoseoverthetermoftheleaseinaccordancewithIAS16.Thecompanyhasanobligationundertheleasetoremovetheimprovementsattheendoftheleaseterm.Theobligationarisesasthecompanycompletestheimprovementsandthisrepresentsapastevent.Therefore,iftheimprovementshavebeenmadebythecompanysyearendaprovisionofthepresentvalueofCU500000in15yearstimeshouldbemadefortheireventualremoval.Inaddition,anassetofthesameamountshouldberecognizedforwhatis,ineffect,decommissioning,whichwillberecoveredfromthebenefitsgeneratedbythebusinessoverthetermofthelease.Theassetshouldthenbeamortizedovertheremainingleaseterm.

2. Anentitythatoperatesachainofretailoutletsdecidesnottoinsureitselffortheriskofminoraccidentstocustomers.Insteaditoptstoselfinsure.ItspastexperiencesuggestsitwillpayCU200000inrespectofsuchaccidents.

Howshouldthecompanyaccountforthisrisk?

Anobligationtoanotherpartydoesnotariseuntilsuchtimeasanaccidentoccurs.ThismeansthatunderIAS37rulesaprovisionofalargeramountthanthecostoftheactualaccidentsisnotpermitted.Therefore,ifnoaccidentshaveoccurredasattheyearend,thereisnopresentobligationtoanotherpartyandhencenoprovisionshouldbemade.Clearly,whereanaccidenthashappenedtheretailermightnotknowofitsoccurrencebutthisinitselfdoesnotprecludeitfrommakingaprovision.Aslongastheentityhasatrackrecordofclaimsexperiencefromwhichitcanestimatethelevelofaccidentsthathaveoccurredbutwhichhavenotyetbeenreporteditmaymakeaprovisionforitsestimateoftheobligation.

3. AcompanyexpectstobefinedCU250000forthetimetakeninsettlingitspensionmisspellingobligation.Atitsyearend,thecompanyhasnotpaidthefine,butitknowstheamountitwillhavetopayfrompublishedrates.ItanticipatesthatithasapensionmisspellingobligationofCU5m,butitstillneedstocalculatehowmuchtorepayitscustomersandwhothosecustomersare.Itisgoingtohavetoemployanumberofadditionalstafftodothisworkasitsexistingemployeesarefullyutilizedinrunningthebusiness.ThecostoftheseadditionalstaffisestimatedtobeCU300000.Inaddition,theregulatorhasrequestedthatitmakecertainsystemchangestothewayitsellspensionsandthisisexpectedtocostthecompanyafurtherCU500000,CU100000ofwhichrelatestotrainingcosts.

Howshouldthecompanyaccountforthesecosts?

Thepensionmisspellingobligationsclearlyarisefromapastevent,whichwastheoriginalsaleofpersonalpensionstocustomers.Ifthesimpleyearendtestisappliedasifthecompanydiscontinuedtradeatitsyearend,thecompanywouldberesponsibleforpayingthefineofCU250000.Inaddition,itwouldhaveanobligationofCU5mtocompensateitscustomersformisspellingthempersonalpensions.Also,itwouldhavetoincurcostsofCU300000incalculatingtheamountstobesettledandinascertainingtowhompaymentsshouldbemade.Wherethecompanyemploysadditionalstafftocarryoutthiswork,itisclearthattheseincrementalcostsshouldbeprovidedfor.Butitwouldnotbeappropriateforthecompanytoprovidea



proportionofitsoverheadcostssuchasadministrativeexpenses.ClearlythecostsofCU400000torectifythecompanyssystemsandtheCU100000trainingcostsrelatetothecompanysfutureoperationsandarenoteligibleforprovision.

IAS37Provisions,contingentliabilitiesandcontingentassetsOnerouscontracts


ONEROUS CONTRACTS

1. Anenterpriseoperatesprofitablyfromafactorythatithasleasedunderanoperatinglease.DuringDecemberX0theenterpriserelocatesitsoperationstoanewfactory.Theleaseontheoldfactorycontinuesforthenextfouryears,itcannotbecancelledandthefactorycannotberelettoanotheruser.

Determinewhetheraprovisionshouldberecognized(IAS37AppendixC).

Theobligatingeventisthesigningoftheleasecontract,whichgivesrisetoalegalobligation.Whentheleasebecomesonerous,anoutflowofresourcesembodyingeconomicbenefitsisprobable.(Untiltheleasebecomesonerous,theenterpriseaccountsfortheleaseunderIAS17,Leases).Aprovisionisrecognizedforthebestestimateoftheunavoidableleasepayments(seeIAS37.5(c),.14and.66).

2. Acompanyhasacontracttopurchaseonemillionunitsofgasat0.23perunitgivingacontractpriceofCU230000andthecurrentmarketpriceforasimilarcontractis0.16perunitgivingapriceofCU160000.

Givetheappropriateaccountingtreatmentinthefollowingsituations(PWC,pg21063)

a. Thegaswillbeusedingeneratingelectricityandtheelectricitywillbesoldataprofit.

Theeconomicbenefitsfromthecontractincludethebenefitstotheentityofusingthegasinitsbusinessandbecausetheelectricitythatisproducedcanbesoldataprofit,thecontractisnotonerous.

b. Whenthegasisusedtogenerateelectricity,thehighcostsofthegasmeansthattheelectricityissoldatalossandtheentitymakesanoveralloperatingloss.Assumethatallthegasusedbytheentitytogenerateelectricityispurchasedunderthecontract.Astheentityismakinglosses,itwillbenecessarytocarryoutanimpairmenttestontheCGUthatgeneratestheelectricityandwritedownanyassetsthatareimpaired.Totheextentthatthereisstillalossaftertheassetshavebeenfullywrittendown,thebalanceshouldbeprovidedforasaprovisionforanonerouscontract.Theimpairmenttestshouldbecarriedoutbyreferencetothenormaltimespanforimpairmenttestingandnotbyreferencetothecontractsduration.c. Thereisasalescontracttosellthegasontoathirdpartyasitisinexcessoftheentitysrequirements.Thesalescontractispricedat0.18perunit.TheentitywouldhavetopayCU55000toexitthepurchasecontract.

OnlyeconomicbenefitstobederivedfromthepurchasecontractcostingCU230000aretheproceedsfromthesalescontract,whichareCU180000.ThereforeaprovisionshouldbemadefortheonerouselementofCU50000,beingthelowerofthecostoffulfillingthecontractandthepenaltycostofcancellation(CU55000).

3. Acompanyhasa10yearleaseonapropertyatarentalofCU50000perannum.ThemarketrentisCU30000perannum.

Howshouldthecompanyaccountforthisleaseinthefollowingsituations?

a. Thepropertyisusedinthebusinessandthebusinessislossmaking.ThereisanindicationofimpairmentintheCGUandtheCGUsassetsshouldbereviewedforimpairmentandwrittendown.Iftheimpairmentlossexceedstheassetscarryingvalue,thebalanceshouldbeprovidedasaprovisionfortheonerouslease.



b. Theentitynolongeroccupiesthepropertyanditisnotusedinthebusiness.AsubleaseonthepropertyhasbeenarrangedatarentofCU30000ayearfor10years.Thecompanyhasestablishedthatthenetcostofcontinuingwiththeleaseislessthanthepenaltyforexitingthelease.

ThemaximumbenefitstobederivedfromthecontractareCU30000for10years.ThecashinflowofCU30000shouldbedeductedfromthecashoutflowsofCU50000andthebalanceofCU20000shouldbediscountedusingariskfreeratetogivetheamountthatshouldbeprovidedontheonerouselementofthelease.

c. Thepropertyisemptyandisnotsublet.However,thecompanyisabank(oraretailer)andalsohaslotsofotherpropertieswheretheleasesareabovemarketrates.Thecompanydoesnotconsideritisfairtoprovideforthislease,inisolation.Itmayormaynotreopenthepropertyanduseitagaininitsbusiness.

Ifitisonlyapossibilitythatthepropertywillbeusedagaininthebusiness,theprudentapproachwouldbetoprovide.However,wheretheentityplanstousethepropertyagaininitsbusiness,itisnecessarytolookattheCGUofwhichthepropertyformspart.ThisCGUwillnotnecessarilyincludeallofthecompanysproperties,butonlythosethatformpartoftheCGU.TheCGUisthenassessedforimpairmenttakingaccountofthenetcashoutflowsfromtheemptyproperty.IftheCGUhassufferedanimpairmentthentheassetsshouldbewrittendown,iftheamountoftheimpairmentismaterial.

d. Thepropertyisemptyandisnotsublet.However,thecompanyisabank(oraretailer)andalsohaslotsofotherpropertieswheretheleasesareabovemarketrates.Thecompanyintendseithernevertousethepropertyagainand/ortodisposeofthelease

ThepropertyleasecannotbeviewedinconjunctionwiththeCGUofwhichitformspart,becausewhereanassetisheldforsaleitdoesnotbelongtoanyotherCGU,butisconsideredtobeaCGUofitsown.Provisionshould,thereforebemadefortheonerouscontract.

4. Acompanyhasanoperatingleaseonaretailstore.Theairconditioningsystemisunreliableandthecompanyproposestoreplaceit.Thestorewillbeclosedwhiletheworksarecarriedout.

Canthecompanyprovideinadvancefortherentthatispayableduringthecloseperiod?

IAS37doesnotpermitprovisionstobemadeforfutureoperatinglosses.Theeconomicbenefitsofthestoreslease,theeconomicbenefitsfromitincludethefuturecashflowsthatareexpectedtobeearnedfromoperatingthestore.Theleasewouldbeonerousonlyiftherentalsforitsfulltermcouldnotberecovered(inpresentvalueterms)fromthefuturecashflows.5. Acompanyhasa10yearleaseonapropertyatarentalofCU50000perannumandthemarketrentisCU30000perannum.However,thecompanynolongerusesthepropertyandneverwilldosoagain.Itis,therefore,goingtomakeaprovisionforanonerouscontract.Ithasnotyetfoundasublessee,butexpectstodososoon.

Isitacceptableforthecompanytoanticipatethefuturesubleaseindeterminingtheprovisiontobemade?

Theexpectedbenefitstobereceivedshouldbetakenintoaccount.Consequently,itisreasonabletotakeaccountoftheexpectedrenttobereceivedunderasubleaseindeterminingtheprovision,providedthatthecompanyisactivelyseekingtosublettheproperty,thereisevidence(fromestateagentsorsimilar)thatthepropertycanbelet,andthereisreasonableevidenceastotherentthatmaybeobtainedinanopenmarketrental.



6. AidaNVsignsathreeyearcontractwithRamadesSA.Managementcanestimatetheoutcomeofthecontractreliablyattheendofyear1.AtthatmomentestimatedtotalcontractrevenueisCU2400andtotalcostswillbeCU2000.CU800wereincurredduringyear1(Cethys,2008).a. Calculatethepercentageofcompletionofthecontractattheendofyear1,andtheamountsof

revenueandcoststhatwillbeincludedintheprofitandlossstatement.

Totalrevenue 2400Estimatedcoststocomplete (2000)Estimatedtotalgrossprofit 400

Costsincurredtodate 800Totalestimatedcosts 2000Percentageofcompletionatendofyear1 40%Recognizedcosts 800Recognizedrevenue 960Profit 160

b. Inyear2,costsofCU900areincurred.ManagementestimatesthatthecoststocompletethecontractareCU1000.Calculatetheamountofrevenueandcosttoincludeintheprofitandlossstatement.

Costsincurredtodate 1700Estimatedcoststocomplete 1000Totalestimatedcosts 2700Estimatedrevenue 2400Estimatedloss (300)

ThelossofCU300isrecognizedimmediatelyasanexpenseinyear2.Inaddition,theprofitofCU160recognizedinyear1isreversed,whichleadstoatotallossrecognizedinyear2ofCU450.

IAS37Provisions,contingentliabilitiesandcontingentassetsRestructurings


RESTRUCTURINGS

RECOGNITION OF A RESTRUCTURING PROVISION

Determinewhetherarestructuringprovisionshouldberecognizedinthefollowingsituations:

1. On12DecemberX0theboardofanenterprisedecidedtoclosedownadivision.a. Beforethebalancesheetdate(31December20X0)thedecisionwasnotcommunicatedtoanyofthoseaffectedandnootherstepsweretakentoimplementthedecision.

Therehasbeennoobligatingeventandsothereisnoobligation.Noprovisionisrecognized.

b. On20December20X0adetailedplanforclosingdownthedivisionwasagreedbytheboard;lettersweresenttocustomerswarningthemtoseekanalternativesourceofsupplyandredundancynoticesweresenttothestaffofthedivision.

Theobligatingeventisthecommunicationofthedecisiontothecustomersandemployees,whichgivesrisetoaconstructiveobligationfromthatdate,becauseitcreatesavalidexpectationthatthedivisionwillbeclosed.Anoutflowofresourcesembodyingeconomicbenefitsinsettlementisprobable.Aprovisionisrecognizedat31DecemberX0forthebestestimateofthecostsofclosingthedivision(seeIAS37.14and.72).

2. Acompanyhasannouncedatitsyearendthatithasputasubsidiaryupforsaleandifitcannotfindabuyeritwillclosedowntheentity.

Itishardtosaythatthecompanyiscommittedtoacourseofactionifitstillhasoptionsopentoit.Therefore,companycannotmakeprovisionforthereorganisationalthoughitmayhavetodoanimpairmentreview.

3. CompanyAacquirescompanyB,effective1March20X5.Atthedateofacquisition,companyAintendstocloseadivisionofcompanyB.Asatthedateofacquisition,managementhasdevelopedandtheboardhasapprovedthemainfeaturesoftherestructuringplanand,basedonavailableinformation,bestestimatesofthecostshavebeenmade.Asatthedateofacquisition,apublicannouncementofcompanyAsintentionshasbeenmadeandrelevantpartieshavebeeninformedoftheplannedclosure.Withininaweekoftheacquisitionbeingeffected,managementcommencestheprocessofinformingunions,lessors,institutionalinvestorsandotherkeyshareholdersofthebroadcharacteristicsofitsrestructuringprogram.Adetailedplanfortherestructuringisdevelopedwithinthreemonthsandimplementedsoonthereafter.

ShouldcompanyAcreateaprovisionforrestructuringaspartofitsacquisitionaccountingentries?

NounderIFRS3theacquirercannotrecognizetheprovisionifitisnotalreadyrecognizedasaliabilityoftheacquiree.

HowwouldyouranswerchangeifallthecircumstancesarethesameasthoseaboveexceptthatcompanyAdecidedthat,insteadofclosingadivisionofcompanyB,itwouldclosedownoneofitsownfacilities?

Inthissituation,althoughtheclosingofthefacilityonlyarisesbecauseoftheproposedacquisition,whetherornotapresentobligationexistswouldneedtobeconsideredinaccordancewiththerequirementsforaninternalrestructuringasopposedtoarestructuringrecognizedaspartofanacquisition.Thisisbecauserequirementsrelatingtorestructuringprovisionsrecognizedaspartofanacquisitionrelateonlytoassetsandliabilitiesoftheacquiree.Sincetheintendedclosurerelatestoanoperationoftheacquirer,arestructuringprovisioncannotberaisedinthebooksoftheacquireeandcannotbeconsideredaspartofarestructuringrecognizedaspartofanacquisition



COST OF RESTRUCTURING

1. Determinewhetherthefollowingcostsshouldbeincludedorexcludedwhenmeasuringtherestructuringprovision(PWC,pg21057)

Descriptionofcosts Included/excluded ReasonforexclusionVoluntaryredundancies InCompulsoryredundancies,ifthetargetforvoluntaryredundanciesarenotmet

In

Leasecancellationfeesforafactorythatwillnolongerbeused

In

Relocationofemployeesandrelatedequipmentfromafactory(tobeclosed)toafactorythatwillcontinuetobeused

Ex Costsassociatedwithongoingactivities

Retrainingofremainingemployees Ex Costsassociatedwithongoingactivities

Recruitmentcostsforanewmanager Ex Costsassociatedwithongoingactivities

Marketingcoststodevelopnewcorporateimage


Investementsinanewdistributionnetwork Ex Costsassociatedwithongoingactivities

Futureidentifiableoperatinglossesuptothedateofarestructuring


Impairmentwritedownofcertainproperty,plantandequipment

Ex TheimpairmentprovisionshouldbeassessedinaccordancewithIAS36andoffsetagainsttheasset

Costsoftheremainingnoncancellabletermofanoperatingleaseafteroperationscease

In

RConsultingfeestoidentifyfuturecorporatestrategiesandorganizationalstructures


Costsofrelocatinginventoryandequipmentthatwillbeusedatanotherlocation




2. CompanyTsdirectorsdecidedon3May20X5torestructurethecompanysoperationsasfollows(Alfredson,pg192,Problem5.1): FactoryZwouldbecloseddownandputonthemarketforsale. 100employeesworkinginFactoryZwouldberetrenchedeffective31May20X5andwouldbepaid

theiraccumulatedentitlementsplus3monthswages. Theremaining20employeesworkinginFactoryZwouldbetransferredtoFactoryX,whichwould

continueoperating. 5headofficestaffwouldberetrenchedeffective30June20X5andwouldbepaidtheiraccumulated

entitlementsplus3monthswages.

AsatCompanyTsbalancesheetdateof30June20X5thefollowingtransactionsandeventshadoccurred:

FactoryZwasshutdownon31May20X5.Anofferof4mhadbeenreceivedforFactoryZbutthereisnobindingsalesagreement.

The100retrenchedemployeeshaveleftandtheiraccumulatedentitlementshadbeenpaid.Howeveranamountof76000,representingaportionofthe3monthswagesfortheretrenchedemployees,hadstillnotbeenpaid.

Costsof23000wereexpectedtobeincurredintransferringthe20employeestotheirnewworkinFactoryX.Thetransferwilloccuron14July20X5.

Fourofthefiveheadofficestaffhadbeenretrenched,hadleftandtheiraccumulatedentitlements,includingthe3monthswages,hadbeenpaid.Howeveroneemployee,JerryPerry,remainedontocompleteadministrativetasksrelatingtotheclosureofFactoryZandthetransferofstafftoFactoryX.Jerrywasexpectedtostayuntil31July20X5.JerryssalaryforJulywouldbe4000andhisretrenchmentpackagewouldbe13000,allofwhichwouldbepaidonthedayheleft.Heestimatedthathewouldspend60%ofhistimeadministeringtheclosureofFactoryZ,30%ofhistimeadministeringthetransferofstafftoFactoryXandtheremaining10%ongeneraladministration.

CalculatetheamountoftherestructuringprovisionrecognizedinCompanyTsfinancialstatementsasat30June20X5,inaccordancewithIAS37.

Anofferof4mhadbeenreceivedforFactoryZ;howevertherewasnobindingsalesagreement:Thisisaredherringthebindingsaleagreementtestinpara.78appliestothesaleofanoperation.Inthiscasethefactoryhasalreadybeenshutdownandthustheimplementationoftherestructuringhasvirtuallybeencompleted.Theliabilityrelatingtotheretrenchedpersonnelshouldbeincludedintheprovisionastheimplementationoftherestructuringhascommencedandtheamountrepresentsapresentobligation.Thecostotherelocationoftheremainingemployeesisnotincludedsincethecostsrelatetoongoingoperations.Theamounttobeprovidedfortheheadofficestaffis(60%*4000)+13000=15400.

Thereforetotalprovision=76000+15400=91400.

IAS37Provisions,contingentliabilitiesandcontingentassetsChangesinexistingdecommissioning,restorationandsimilarliabilities


IFRIC 1 CHANGES INEXISTING DECOMMISSIONING, RESTORATION AND SIMILAR LIABILITIES

1. TheKoebergOffshoreOilRighasrecentlybeenconstructed,andwillbecommencingproductionduringthecurrentfinancialyear.Managementestimatesthattheoilfieldhasausefullifeof10years,followingwhichtherigwillneedtobedismantledandremovedfromthesiteandthearearestoredtoitsoriginalcondition.Theestimatedcostofthisdecommissioningamountsto900000CUforthedismantlingoftherigandthecappingofthewellheadand100000CUforfinalclearingofresidualpollutiondamagewhichislikelytooccurthroughnormalproductionactivityoverthe10yearperiod.Thecostofcapitaloftheenterpriseisestimatedat5%p.a.

YoumayassumethattheKoebergOilRigwasconstructedinyear0andthatitwillcomeintoproductiononthefirstJanuaryofthecurrentfinancialyear(=year1).

Givetheaccountingentriesforyear0toyear10.

a. Year0

Assumingadiscountrateof5%p.a.,wecancalculatethepresentvalueofthedecommissioningcostsrelatedtoconstruction:PV=900000/(1+0,05)10=552522

Dr Asset 552522Cr Provisionfordecommissioning 552522

b. Theendofyear1

Clearingcostsrelatedtoproductionforyear1:PV=10000/(1+0,05)9=6446

Accrualofinterestontheprovisionsmadeinyearsbefore(underIAS37):0,05*552522=27626

Depreciationoftheasset:552522/10=55252,2

Dr Expenses 6446Cr Provisionforclearing 6446Dr Interestexpense 27626Cr Provisionfordecommissioning 27626Dr Depreciationexpense 55252,2Cr Accumulateddepreciation 55252,2

c. Theendofyear2


Accrualofinterestontheprovisionsmadeinyearsbefore(underIAS37):

0,05*(552522+27626)=29007

0,05*6446=322


Dr Expenses 6768Cr Provisionforclearing 6768Dr Interestexpense 29007Cr Provisionfordecommissioning 29007



Dr Interestexpense 322Cr Provisionforclearing 322Dr Depreciationexpense 55252,2Cr Accumulateddepreciation 55252,2

d. Theendofyear10


Accrualofinterestontheprovisionsmadeinyearsbefore(underIAS37):

0,05*(552522+27626+29007+30458+31981+33580+35259+37022+38873+40816)=42857

0,05*(6446+322+6768+677+7107+1066+7462+1492+7835+1959+8227+2468+

8638+3023+9070+3628+9524)=4286


Dr Expenses 10000Cr Provisionforclearing 10000Dr Interestexpense 42857Cr Provisionfordecommissioning 42857Dr Interestexpense 4286Cr Provisionforclearing 4286Dr Depreciationexpense 55252,2Cr Accumulateddepreciation 55252,2e. Year11

Payingforthedismantlingoftherigandthecappingofthewellheadandforfinalclearingofresidualpollution

Dr Provisionfordecommissioning 900000Cr Cash 900000Dr Provisionfordecommissioning 100000Cr Cash 0



2. Anentityhasanuclearpowerplantandarelateddecommissioningliability.Thenuclearpowerplantstartedoperatingon1January20X0.Theplanthasausefullifeof40years.ItsconstructioncostwasCU110000.Theentityestimatesthatthecashoutflowfordecommissioningcostin40yearswillbeCU70400.Theriskadjustedrateis5%.Theentitysfinancialyearendson31December(BasedonIEinIFRIC1).a. Accountfortheinitialcostofthepowerplantat1January20X0PVof70400,discountedat5%over40yearsis10000.

Dt Powerplant(constructioncost)(A) 110000Dt Powerplant(ARO)(A) 10000Ct Suppliers(L) 110000Ct Provisionforassetretirementobligation(L) 10000

b. Givetheaccountingentrieson31December20X0

Dt Depreciationcost(IS) 3000Ct Powerplant(constructioncost) 3000Dt Financecost 500Ct Liability 500

c. On31December20X9,thediscountratehasnotchanged.However,theentityestimatesthat,asaresultoftechnologicaladvances,theestimatedoutflowforthedecommissioninginyear40willnotbeCU70400,but35200.Accountforthischangeinestimate.

On31December20X9,theplantis10yearsold.AccumulateddepreciateddepreciationisCU30000(CU120000*10/40years)).Becauseoftheunwindingofdiscount(5%)overthe10years,thedecommissioningliabilityhasgrownfromCU10000toCU16300.ThepresentvalueofCU35200isCU8144.

Dt Liability(163008144) 8156Ct Powerplant(ARO) 8156

NotethattheseparatecomponentfortheAROisonlyCU7500atthismoment.Theaccountingvalueofthepowerplantisnow:120000300008156=81844.

d. Givetheaccountingentrieson31December20X10

Dt Depreciationcost(IS) 2728Ct Powerplant(constructioncost) 2728Dt Financecost 407Ct Liability 407

e. On31December20X11theentitystillbelievesthatitscashoutflowfordismantlingtheplantwillbeCU35200,butitrevisesitsdiscountrateto4%.Givetheappropriateaccountingentries.

Dt Depreciationcost(IS) 2728Ct Powerplant(A) 2728Dt Financecost(IS) 428Ct Liability(L) 428

Thecarryingamountoftheliabilitybeforeadjustmenttothenewdiscountrateis:CU8144+CU407+CU428=CU8979.Basedonthenewdiscountrateof4%,thepresentvalueofCU35200over29yearsis11287,thereforethefollowingaccountingentryshouldbemade:

Dt Powerplant(A) 2308Ct Provisionforassetretirementobligation(L) 2308



f. On31December2012,nothinghaschanged.Givetheappropriateaccountingentries.

Dt Depreciationcost(IS) 2 728Ct Powerplant(A) 2728Dt Financecost(IS) 452Ct Liability(L) 452

I I

IAS37Provisions,contingentliabilitiesandcontingentassetsFinancialguaranteecontracts


FINANCIAL GUARANTEE CONTRACTS

On31December20X2,entityAgivesaguaranteeofcertainborrowingsofentityB,whosefinancialconditionatthattimeissound.ThetransactionisatfairvalueandentityAreceivesapremiumfortheguarantee,whichitwilldeferandrecognizeasincomeovertheperiodoftheunderlyingriskexposure.Undertheguaranteesterms,entityAwillmakespecidiedpaymentstoreimbursetheholderforanylossitincursifentityBfailstomakepaymentwhendue.

Givetheaccountingtreatmentat31December20X2

Theobligatingeventisthegivingoftheguarantee,whichgivesrisetoalegalobligation.At31December20X2,thefinancialpositionofentityBissound.Therefore,anoutflowofeconomicbenefitsisnotprobableat31December20X2.Theguaranteeisinitiallyrecognizedatfairvaluewhichisthevalueofthepremiumreceived.

During20X3,thefinancialconditionofentityBdeterioratesandat30June20X3entityBfilesforprotectionfromitscreditors.HowwillAtreatthis?

Theobligatingeventisthegivingoftheguarantee,whichgivesrisetoalegalobligation.At31December20X3thefinancialpositionofentityBhasdeterioratedsuchthatitisprobablethatanoutflowofeconomicbenefitswillberequiredtosettletheobligation.Theguaranteeissubsequentlymeasuredatthehigherof(a)thebestestimateoftheobligationdeterminedinaccordancewithIAS37,and(b)theamountinitiallyrecognizedlesscumulativeamortization.

IAS37Provisions,contingentliabilitiesandcontingentassetsCustomerloyaltyprogrammes


IFRIC 13 CUSTOMER LOYALTYPROGRAMMES

Howshouldtheentityaccountforthefollowingprogrammes?

1. Agroceryretaileroperatesacustomerloyaltyprogramme.Itgrantsprogrammemembersloyaltypointswhenevertheyspendaspecifiedamountongroceries.Programmememberscanredeemthepointsforfurthergroceries.Thepointshavenoexpirydate.Inoneperiod,theentitygrants100points.Managementexpects80ofthesepointstoberedeemed.Managementestimatesthefairvalueofeachloyaltypointtobeonecurrencyunit(CU1).Inyear1,40pointsareredeemedinexchangeforgroceries.Inthesecondyear,managementrevisesitsexpectations.Itnowexpects90pointstoberedeemedaltogether.Duringthesecondyear,41pointsareredeemed,bringingthetotalnumberredeemedto40+41=81points.Inthethirdyear,afurtherninepointsareredeemed,takingthetotalnumberofpointsredeemedto81+9=90.Managementcontinuestoexpectthatonly90pointswilleverberedeemed,i.e.thatnomorepointswillberedeemedafterthethirdyear.

Inperiodthattheentitygrants100pointsitdefersrevenueofCU100.

Year1:Theentityrecognizesrevenueof(40points/80points)CU100=CU50.

Year2:Thetotalrevenuethattheentitynowrecognizesis(81points/90points)CU100=CU90.TheentityhasalreadyrecognizedrevenueofCU50inthefirstyear,soitrecognizesafurtherCU40inthesecondyear.

Year3:Thecumulativerevenuetodateis(90points/90points)CU100=CU100.TheentityhasalreadyrecognizedCU90ofrevenue(CU50inthefirstyearandCU40inthesecondyear).SoitrecognizestheremainingCU10inthethirdyear.Alloftherevenueinitiallydeferredhasnowbeenrecognized.

2. Aretailerofelectricalgoodsparticipatesinacustomerloyaltyprogrammeoperatedbyanairline.ItgrantsprogrammemembersonepointwitheachCU1theyspendonelectricalgoods.Programmememberscanredeemthepointsfortravelwiththeairline,subjecttoavailability.TheretailerpaystheairlineCU0,009foreachpoint.Inoneperiod,theretailersellselectricalgoodstotalingCU1million.Itgrants1millionpoints.TheretailerestimatesthatthefairvalueofapointisCU0,01.

Theentityallocates1million*CU0,01=CU10000oftheconsiderationithasreceivedfromthesalesofitselectricalgoodstothepoints.Havinggrantedthepoints,theretailerhasnofurtherobligationstothecustomer.Theairlineisobligedtosupplytheawardsandentitledtoreceiveconsiderationfordoingso.Theretailerrecognizesrevenuefromthepointswhenitsellstheelectricalgoods.Iftheretailerhascollectedtheconsiderationallocatedtotheawardcreditsonitsownaccount,itmeasuresitsrevenueasthegrossCU10000allocatedtothepoints.ItseparatelyrecognizestheCU9000paidorpayabletotheairlineasanexpense.Iftheretailerhascollectedtheconsiderationonbehalfoftheairline,i.e.asanagentfortheairline,itmeasuresitsrevenueasthenetamountitretainsonitsownaccount.ThisamountofrevenueisthedifferencebetweentheCU10000considerationallocatedtothepointsandtheCU9000passedontotheairline.

IAS37Provisions,contingentliabilitiesandcontingentassetsED2010/1MeasurementofliabilitiesinIAS37


ED 2010/1 MEASUREMENT OF LIABILITIES IN IAS 37

Anoilproductioncompanyownsandoperatesanoilrig.Existingenvironmentallawsobligerigownerstodismantlerigsthathavereachedtheendoftheirusefullives.Rigownerscannotcancelsuchobligations,ortransferthemtoathirdparty.However,therearecontractorsinthemarketthatprovidedismantlingservicesforrigowners.Acontractorwouldcharge125,000currencyunits(CU125,000)todismantletheoilcompanysrignow,inawaythatcomplieswithexistingenvironmentallaws.Therighasanestimatedremainingusefullifeof1015years.Thecurrent10yearand15yearriskfreeratesofinterestarerespectively6and5.5%peryear.

Theentityestimatestheprobabilityofeachoutcomeoccurring.Itcalculatestheprobabilityweightedaverageofthepresentvaluesforthesixoutcomes.

Outcome Usefullifeofrig Estimatedoutflow(contractorprice)

Estimatedprobability

1 10years 200,000 5%2 10years 225,000 25%3 10years 275,000 20%4 15years 230,000 5%5 15years 260,000 25%6 15years 340,000 20%

TheCU125,000thatacontractorwouldchargetodismantletherigincludesapriceforrisk,butonlyinrespectofuncertaintiesinthecoststhatthecontractorwouldincurtodismantletherignow.Itdoesnottakeintoaccounttheadditionalriskthatarisesbecauseofuncertaintyabout:

(a)howpriceswillchangebetweennowandtheendoftherigsusefullife;and(b)whentherigwillreachtheendofitsusefullife.

Theentityestimatesthatitwouldrationallypayanadditional5%toberelievedofthisrisk:

Accountfortheliability

IAS37Provisions,contingentliabilitiesandcontingentassetsED2010/1MeasurementofliabilitiesinIAS37


Measurementbasis:Becausetheoilcompanycannottransferorcancelitsobligation,itneednotconsidertheamountsitwouldhavetopaytodoso.Itmeasurestheliabilityasthepresentvalueoftheresourcesrequiredtofulfilltheobligation.

Outflowsofresources:Estimatesoffuturepriceincreasestakeintoaccountpossiblemarketandtechnologicaldevelopments.Theentityestimatestheprobabilityofthesedevelopmentsoccurringonthebasisofexperience,marketdata,technologicalinformationandsimilarevidence.Theestimatesoffuturepricesarebasedonexistinglegalrequirements:theydonottakeintoaccountthepossibilitythatthelegalrequirementswillbemoreonerousattheendoftherigsusefullifethantheyareatpresent.

Outcome Estimatedoutflow(contractorprice)

Discountedvalue(6%foroutcome1,2,3;5.5%foroutcome4,5,6)

Estimatedprobability

Weightedamount

1 200,000 111,679 5% 5,5842 225,000 125,639 25% 31,4103 275,000 153,559 20% 30,7124 230,000 103,025 5% 5,1515 260,000 116,463 25% 29,1166 340,000 152,297 20% 30,459Expectedpresentvalueofoutflows 132,432Riskadjustment(5%) 6,622Amountthattheentitywouldrationallypayattheendofthereportingperiodtoberelievedoftheobligation

139,054

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