18 Provisions, Contingencies and EARP s22 - Final

Solutions to GAAP : Graded Questions Provisions, contingencies and events after the reporting
period
Solution 18.1
a.
Which of the following statements are correct?
1. A provision is a liability for which the amount is estimated.

2. A provision is not recognised on the statement of financial position.
a) 1 only
b) 2 only
c) Both 1 and 2 are correct
d) Both 1 and 2 are incorrect
b.
Which of the following does not create a constructive obligation under IAS 37?
a) Established pattern of past practice

b) Legislation
c) Published policies
d) A current statement
Legislation creates a legal obligation under IAS 37.

A constructive obligation is an obligation derives from an entity’s actions whereby a valid expectation is created
that it will discharge responsibilities. These may be created by:
• An established pattern of past practice
• Published policies
• A sufficiently current statement
(IAS 37.10)
c.
A provision is the same as an accrual.
a) True
b) False
Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid,
invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating
to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the
uncertainty is generally much less than for provisions. Accruals are often reported as part of trade and other
payables, whereas provisions are reported separately.
(IAS 37.11)
© Service & Kolitz, 2022 2023 Chapter 18: Page 1

period
Solution 18.1 continued . . .
d.
Which of the following statements are correct?
1. Obligations arising from past events that exist independently of an entity’s future actions are
recognised as provisions
2. Obligations arising from past events that an entity can avoid by its future actions are recognised as
provisions
3. Costs relating to past environmental damage are an example of an obligation that exists
independently of an entity’s future actions
4. Costs relating to the fitting of partitions for a smoking section in a restaurant that is required by law
are an example of an obligation that exists independently of an entity’s future actions
a) 2, 3 and 4 are correct

b) 1 and 3 are correct
c) 1 only is correct
d) 1, 3 and 4 are correct
e) 2 and 3 are correct
e.
Grandi plc is a retailer of fashionable sports clothing. The trial balance at 31 December 20X1, the end
of its financial year shows closing inventory at a cost of C100 000. The financial statements are
authorised for issue on 15 February 20X2.
1. If the inventory is sold for C80 000 before 15 February 20X2, in the 20X1 financial statements,
C20 000 is recognised in cost of sales and the inventory will be reported on the statement of
financial position at C80 000.
2. If the inventory is sold for C80 000 after 15 February 20X2, in the 20X1 financial statements,
C20 000 is recognised in cost of sales and the inventory will be reported on the statement of
financial position at C80 000.
C20 000 is recognised in other comprehensive income and the inventory will be reported on the
statement of financial position at C80 000.
C20 000 is recognised in other comprehensive income and the inventory will be reported on the
statement of financial position at C120 000.

period
Solution 18.2
Introduction
It is necessary to determine whether or not the costs to install the new smoke reduction filters or the
possibility of a fine meet the definition of a provision.
Definitions
IAS 37 defines a provision as
• a liability
• of uncertain timing or amount. IAS 37.10
A provision recognised when

• there is a present obligation (legal or constructive),
• from a past event,
• the settlement of which will lead to a probable outflow of resources and the amount can be reliably
estimated. IAS 37.14
Present obligation of the entity
A present obligation is the result of an obligating event. An obligating event is an event:
• that creates a legal or constructive obligation
• that results in an entity having no realistic alternative to settling that obligation. IAS 37.10
A constructive obligation is an obligation that derives from an entity’s actions where:

• by an established pattern of past practice, published policies or a sufficiently specific current
statement, the entity has indicated to other parties that it will accept certain responsibilities, and
• as a result , the entity has created a valid expectation on the part of those other parties that it will
discharge those responsibilities. IAS 37.10
a) Is there a present obligation as a result of a past obligating event at 31 December 20X2?
• No obligation exists because there is no obligating event either for the costs of fitting smoke
reduction filters or for the fines under the legislation.
• Steam Away Limited has also not communicated to the public or other interested parties that they
will be fitting the filters, thereby not creating a valid expectation that they will bear these costs and
thus not creating a constructive obligation.
• Note that the new smoke reduction filters only have to be fitted by 31 October 20X3 and therefore
as at 31 December 20X2 Steam Away Limited will not be liable for a fine.
• For a provision to be recognised, the present obligation must exist independently of the entity’s
future actions - If Steam Away Limited had to close down as at the year-end, will they still be liable
for the costs to fit the filters? The answer to that question will be no, and therefore no present
obligation exists.
Conclusion:
Since no obligation exists - no provision will be recognised.
b) Is there a present obligation as a result of a past obligating event at 31 December 20X3?
Fitting of the smoke reduction filters
• Still no obligation for the costs of fitting the smoke reduction filters because no obligating event
has occurred. No contract has been signed for the fitting of the smoke reduction filters.

period
• Steam Away Limited has also not communicated to the public or other interested parties that they
will be fitting the filters, thereby not creating a valid expectation that they will bear these costs and
thus not creating a constructive obligation.
• For a provision to be recognised, the present obligation must exist independently of the entity’s
future actions. If Steam Away Limited had to close down as at the year-end, will they still be liable
for the costs to fit the filters? The answer to that question will still be no, and therefore no present
obligation exists to fit the smoke reduction filters.
Conclusion:
Since no obligation exists - no provision will be recognised to fit the smoke reduction filters.
Fines for non-compliance with the National Environmental Management Air Quality Act.
• An obligation may arise to pay fines under the legislation (legal obligation) because the obligating
event has occurred (the non-compliance with the Act).
• Note that the new smoke reduction filters had to have been fitted by 31 October 20X3 and therefore
as at 31 December 20X3, Steam Away Limited may become liable for a fine.
Is there an outflow of resources embodying economic benefits in settlement?

• An assessment of probability of incurring fines and penalties by non-compliance with the Act
depends on the details of the legislation and the stringency of the enforcement regime.
• If the fines are likely to be imposed, there will be an outflow of economic benefits.
• A provision will therefore be recognised for the best estimate of any fines that are more likely than
not to be imposed.
Comment:
If the amount of the fines were stated upfront and that they were likely to be imposed - this may result
in a ‘pure liability’ being recognised as opposed to a provision because there will be almost no
uncertainty in its timing or amount.

period
Solution 18.3
Issue
It is necessary to determine whether or not the estimated costs to service the plant and machinery and
the estimated environmental cleaning costs can be recognised as a provision.
A provision is defined as a liability of uncertain timing or amount. IAS 37.10
A provision is recognised when

• an entity has a present obligation (legal or constructive) as a result of a past event;
• it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
• a reliable estimate can be made of the obligation . IAS 37.14
Servicing costs
Need to determine if there is a present obligation as a result of a past obligating event
• The intention or decision to incur expenditure relating to the future is not sufficient to give rise to
an obligation.
• For an event to be an obligating event, the entity must have no realistic alternative to settling the
obligation IAS 37.17
• Provisions are recognised only for obligations that exist independently of an entity’s future actions.
Where an entity can avoid future expenditure by its future actions, for example, changing its
methods of operations, it has no present obligation IAS 37.19
• The company has no present legal or constructive obligation as it could avoid this expenditure by
deciding not to service the plant and machinery, or even sell it.
No provision can be recognised for the cost of servicing the plant and machinery in the financial
statements of Fizz plc at 30 December 20X1.
An entry should be recorded to reverse the existing provision

Dr Provision for servicing costs (L); Cr Servicing costs (E)
Environmental cleaning costs
Need to determine if there is a present obligation as a result of a past obligating event
• The company has a published policy of cleaning up any contamination caused by its production
process. It therefore has a present constructive obligation to clean the contamination already caused
to the land (the past obligating event).
• It is probable that an outflow of resources will be required (cash will be used to pay for the clean
up).
• The amount can be reliably measured as quotes have been obtained for C48 000.
A provision of C48 000 can be recognised for environmental cleaning costs in the financial statements
of Fizz pc at 30 December 20X1.

period
Solution 18.4
a) Initial recognition of the previous major inspection
The issue relates to the separate recognition of the previous major inspection.
IAS 16 requires the amount initially recognised as an item of property, plant and equipment to be
allocated to its significant parts, and to depreciate separately each such part (IAS 16.44).
Costs of major inspections are recognised in the carrying amount if the recognition criteria are met (IAS
16.14).
The previous major inspection should be recognised as a separate part of the equipment since it is
significant in cost and has a different useful life to the rest of the equipment.
IAS 16 recognition criteria:
• The inflow of future benefits are probable (entity operates as a going concern).
• The amount is reliably measured (cost of C20 000 and usage to date of acquisition is known).
b) Calculation and journal entries relating to the equipment for the year ended 31 December
20X4
Equipment
body Inspection
01/04/X4 Cost (100 000 – 15 000) 85 000
[20 000 x (3 000 – 750) / 3 000)] 15 000
01/04/X4 – 31/12/X4 Depreciation (85 000 / 10 x 9/12) (6 375)
(15 000 x 1 500 / 2 250) (10 000)
31/12/X4 Carrying amount 78 625 5 000
Explanation
• The previous inspection should be recognised as a separate significant part of the equipment since
it is significant in cost and has a different useful life to the rest of the equipment.
• On initial recognition of the equipment, an ‘inspection’ asset should be recognised at C15 000,
[C20 000 (cost of previous inspection) x (3 000 hrs – 750 hrs) / 3 000hrs].
• The cost of the remainder of the ‘physical equipment’ asset should be recognised at C85 000
(C100 000– C15 000.) upon initial recognition of the equipment.
• Depreciation is based on each significant part separately.
• The physical equipment asset of C85 000 is depreciated over the useful life of 10 years but the
‘major inspection’ asset of C15 000 must is depreciated over the remaining 2 250 hours.
Dr Cr
Equipment: Inspection (A) 15 000
Equipment: cost (A) 15 000
Allocation of significant part / Correction of error
Depreciation (E) 16 375

Accumulated depreciation: Equipment (-A) 6 375
Accumulated depreciation: Inspection (-A) 10 000
Depreciation expense allocated to significant parts

period
c) Recognition of the future inspection
The issue is whether the future major inspection can be recognised as a provision.
A provision is defined as a liability of uncertain timing or amount.
A provision is recognised when

• an entity has a present obligation (legal or constructive) as a result of a past event;
the obligation; and
• a reliable estimate can be made of the obligation.
Provision for the future major inspection
• as the major inspection has not yet occurred, there is no past event;
• therefore there is no present obligation at year end (the major inspection could, in fact, be completely
avoided by selling or otherwise disposing of / abandoning the equipment before the inspection
becomes necessary); and
• since there is neither a past event nor present obligation, the outflow of future economic benefits is
not probable.
The future major inspection may not be recognised as a provision at 31 December 20X1.
However, the new inspection costs will be capitalised when the next inspection is performed and
depreciated as the new operating hours are used up.

period
Solution 18.5
a) Medical waste:
Issues
There are two issues to be discussed here: firstly, whether or not a provision should be raised for the
cost of the disposal of the medical waste on hand at 31 December 20X6 and secondly, whether to
recognise the penalty levied by the Environmental Agency in the 20X6 financial statements.
Discussion
Cost of disposal of medical waste:
In terms of IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a provision is recognised
when the following conditions have been met:
• An entity has a present obligation (legal or constructive) as a result of a past event. In terms of
environmental legislation Park Hospitals Limited has a legal obligation to dispose of medical waste
within two weeks of generation. The generation of the waste is the past event that gives rise to the
legal obligation to dispose of it.
• It is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation. As the company’s incinerator is not working, Park Hospitals Limited will have to
pay Waste Incinerators to dispose of the waste for them, which will result in an outflow of resources.
• A reliable estimate can be made of the amount of the obligation. A contract has been entered into
with Waste Incinerators to dispose of the waste on hand at C10 000 per ton.
As all three conditions have been met a provision of C120 000 should be recognised at 31 December
20X6 for the 12 tons of medical waste on hand that will be disposed of during January 20X7.
Penalty in respect of delayed disposal of medical waste:
The Environmental Agency levied a penalty on the company on 25 January 20X7. This event occurred
after the reporting period, but before the financial statements were authorised for issue on 15 February
20X7. This circumstance meets the definition of an event after reporting date as defined in IAS 10
which defines events after reporting date as those events, favourable and unfavourable, that occur
between the end of the reporting period and the date when the financial statements are authorised for
issue.
The penalty levied on 25 January 20X7 provides evidence of conditions that existed at reporting date
and qualifies as an adjusting event in terms of IAS 10. The company was in contravention of
environmental legislation at 31 December 20X6 and so the condition of a possible penalty existed at
the end of the reporting period. IAS 10 requires adjusting events to be recognised in the financial
statements to reflect adjusting events after reporting date. Therefore Park Hospitals Limited should
adjust the financial statements to recognise a liability of C125 000 at 31 December in respect of the
penalty.

period
Solution 18.5 continued…
b) Legal claim
Issue
The issue to be discussed is whether or not a provision in respect of the legal claim for damages should
be recognised in the financial statements of Park Hospitals Limited at 31 December 20X6.
Discussion
when:
• An entity has a present obligation (legal or constructive) as a result of a past event - As the
company’s legal advisors have reported that it is highly probable that Mr Downe’s claim for
damages will be successful against the company, there is a present obligation as a result of his fall
at the hospital.
the obligation - An amount will have to be paid in damages as the attorneys have indicated that Mr
Downe’s claim will probably be successful, which will result in an outflow of resources.
• A reliable estimate can be made of the amount of the obligation - The directors have applied their
minds to the amount of damages likely to be awarded and have decided that there is not enough
information at the present to make a reasonable estimate. The attorneys will gain a better
understanding of the possible amount of damages after the first court proceedings to be held on
1 March 20X7. Thus a reliable estimate cannot be made at 31 December 20X6.
When a reliable estimate cannot be made IAS 37 requires the liability to be disclosed as a contingent
liability. A contingent liability is defined as a present obligation that arises from past events but is not
recognised because either:
• It is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation. This requirement does not apply to the claim for damages as some form of
damages will be paid; or
• The amount of the obligation cannot be measured with sufficient reliability. This requirement is
applicable as there is uncertainty as to the amount of damages that will be awarded to Mr Downe at
31 December 20X6.
A contingent liability is not recognised in the financial statements but disclosed in the notes to the
financial statements by giving a brief description of its nature, estimate of its financial effect, an
indication of the uncertainties relating to the amount or timing of any outflow, and the possibility of
reimbursement.
PARK HOSPITALS LIMITED

NOTES TO THE FINANCIAL STATEMENTS (EXTRACT)
FOR THE YEAR ENDED 31 DECEMBER 20X6
7. Contingent liability:
The company is currently being sued for damages by a visitor who slipped on a wet floor in one of the
hospitals. Legal advisors have indicated that it is highly probable that the claimant will be successful,
however they are unable to determine the amount of damages likely to be awarded by the court at this
point. The case is to be heard in court on 1 March 20X7, when it will be clearer how much can be
expected to be paid in damages.

period
Solution 18.6
For Parts A, B and C

The following definitions and recognition criteria would be provided in answering Part A, Part B and
Part C. To avoid an unnecessarily long solution, these are provided once and not repeated in each of
the aforementioned parts:
IAS 37 defines a provision as:
• a liability
• of uncertain timing or amount. IAS 37.10
The Conceptual Framework defines a liability as:
• a present obligation of the entity
• arising from a past event
• the settlement of which is expected to result in an outflow from the entity of resources embodying
economic benefits.
As per the Conceptual Framework, a liability must be recognised only if:
the obligation; and
• the amount at which the settlement will take place can be measured reliably.
Part A
The compensation meets the definition of a liability:
• Flyaway Tours Limited has a present legal obligation deriving from the Consumer Protection Act
• The cabin crew strike and cancelled flights is a past obligating event which leads to Flyaway Tours
Limited having no realistic alternative to paying compensation to the stranded passengers.
• In order to settle the obligation, Flyaway Tours will have to pay the passengers (resulting in an
outflow of economic benefits).
It also satisfies the recognition criteria for a liability:
• Since the obligation is imposed by statute, it is probable that Flyaway Tourswill have to honour the
compensation payments.
• The amount payable has been estimated by Flyaway Tours’ lawyers at C2 000 000, using evidence
provided by the statute.
Thus the compensation qualifies for recognition as a liability. However, the amount payable is uncertain
(and will only be confirmed in March) and thus a provision must be recognised in the financial
statements at 31 December 20X8.
Part B

• Flyaway Tours Limited has a present constructive obligation due to the common practice of entities
in the industry to compensate passengers affected by cancelled flights, which has created a valid
expectation on the part of those affected by the flight cancellation that Flyaway Tours will make
such compensation.

period
Solution 18.6 continued
Part B continued . . .
• The cabin crew strike leading to the cancellation is a past obligating event which leads to Flyaway
Tours Limited having no realistic alternative to paying compensation to the injured passengers.

• The obligation derives from a common industry practice, and thus it is probable that Flyaway Tours
will honour the compensation payments (since non-payment would damage the company’s
reputation and possibly influence its market share).
• The amount payable can be estimated based on other similar cancellations which have occurred in
the industry, at an amount of C2 000 000.
Thus the compensation qualifies for recognition as a liability. However, the amount payable is
uncertain, since it is based on the amount usually paid in such situations and thus a provision must be
recognised in the financial statements at 31 December 20X8.
Part C
• The entity has a present constructive obligation which derives from the public announcement made
on 15 January 20X9.
• The public announcement after year end causes the cancellation to become an obligating event. “An
event that does not give rise to an obligation immediately may do so at a later date... because an act
(for example, a sufficiently specific public statement) by the entity gives rise to a constructive
obligation”. IAS 37.21
• Flyaway Tourshas publicly accepted responsibility for compensating the passengers, and thus it is
probable that it will discharge this responsibility (due to the negative consequences of not honouring
the obligation it has accepted).
• The amount payable has been estimated by the company accountants, at an amount of C2 000 000.
Thus the obligation qualifies for recognition as a liability. Since the amount of the obligation is
uncertain (and is based on an estimate by the company’s accountant) a provision must be recognised.
However, there is a difference of opinion regarding when the provision must be recognised, because of
a differing interpretation of when the present obligation arises in a situation such as this one. Both
views are expanded upon below:
One view is that since the cancellation is the obligating event, the obligation exists from the date the
flight was cancelled and the public announcement after year end merely provides evidence regarding
the extent of the obligation (additional evidence provided by events after the reporting period must be
considered when determining whether or not a present obligation exists IAS 37.16). Based on this view, a
provision must be recognised in the financial statements for the year ended 31 December 20X8.

period
Solution 18.6 continued
Part C continued . . .
The opposing view is that, notwithstanding the fact that the cancellation is the obligating event, the
present obligation only arises once the announcement is made. Thus the provision can only be
recognised in the period in which the announcement takes place (and the present obligation arises).
Since the announcement by Flyaway Tours Limited takes place after the reporting period, on this
interpretation no provision must be recognised in the financial statements for the year ended 31
December 20X8. The provision will only be recognised in the year of the announcement, being the
year ended 31 December 20X9.

period
Solution 18.7
a) Accounting treatment for decommissioning costs
Issue
The issue is to determine whether or not to recognise a provision in respect of the future
decommissioning costs.
Discussion
when the following conditions have been met:
• An entity has a present obligation (legal or constructive) as a result of a past event.

• A past event that leads to a present obligation is called an obligating event. The obligating
event is the installation of the desalination plant in terms of the licence.
• The licence granted allows the operation of the desalination plant but includes a clause that
requires the entity to dismantle the plant and restore the area in the future. There is therefore a
legal obligation for the costs associated with the future dismantling and restoration.
the obligation - The company is required to pay the decommissioning costs in the future.
• A reliable estimate can be made of the amount of the obligation - The decommissioning costs are
estimated at C180 000).
This provision must be capitalised to the cost of the plant. This is because assets are measured at cost,
and one of the components of cost is future decommissioning costs. IAS 16.16(c)
Note to student:
Decommissioning and dismantling are two terms that are frequently used in the accounting world to refer
essentially to the same thing. Strictly speaking, ‘decommissioning’ refers to taking an asset (e.g. machine or
plant) out of operation whereas ‘dismantling’ refers to the ‘taking apart’ of an asset.

period
b) Journals
Debit Credit
01/10/X0 Plant: cost (A) 1 500 000
Bank 1 500 000
(Purchase price)
10-12/ X0 Plant: cost (A) 263 220

Bank 263 220
(Installation costs)
01/01/X1 Plant & machinery: decommissioning: cost (A) 111 780

Provision for decommissioning liability 111 780
(PV of future decommissioning costs)
31/12/X1 Finance costs 11 160

Provision for decommissioning liability 11 160
(Unwinding of PV of decommissioning liability)
(122 940 – 111 780)
Depreciation: plant 375 000

Plant: accumulated depreciation 352 644
Plant: accumulated depreciation - decommissioning 22 356
(1 763 220 / 5); (111 780 / 5)
Please note: the accumulated depreciation of each of these two parts – the physical plant versus the expected
costs of decommissioning can be combined into a single accumulated depreciation account if preferred (since the
rate of depreciation is the same in both cases).
c) Disclosure
NEMO LIMITED
EXTRACT FROM STATEMENT OF COMPREHENSIVE INCOME
20X2 20X1
C C
Finance costs 12 240 11 160

period
c) Disclosure continued ...
NEMO LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER 20X2
20X2 20X1
Note C C
Non-current assets
Plant 1 125 000 1 500 000
Cost (1 500 000 + 263 220 + 111 780) 1 875 000 1 875 000
Accumulated depreciation (1 875 000 / 5 X 2) (750 000) (375 000)
(1 875 000 / 5 x 1)
Non-current liabilities
Provision for decommissioning liability 2 135 180 122 940
NEMO LIMITED
EXTRACT FROM NOTES TO THE FINANCIAL STATEMENTS
1. Accounting policies
1.5 Provisions
Provisions are recognised when the company has a present legal or constructive obligation as a result
of past events, it is probable that an outflow of resources will be required to settle the obligation,
and a reliable estimate of the amount can be made.
2 Provision for decommissioning liability

20X2 20X1
C C
Carrying amount at beginning of period 122 940 111 780
Unwinding of discounted present value 12 240 11 160
Carrying amount at end of period 135 180 122 940
The provision for decommissioning liability arises from the dismantling and restoration costs
relating to the plant. These costs are expected to be incurred at 31 December 20X5.
The dismantling and restoration costs are estimated to be C180 000 and are not expected to change.
Workings
Years to Finance
Date decommissioning date 10% discount factor PV costs
01/01/X1 5 0,621 111 780
31/12/X1 4 0,683 122 940 11 160
31/12/X2 3 0,751 135 180 12 240
31/12/X3 2 0,826 148 680 13 500
31/12/X4 1 0,909 163 620 14 940
31/12/X5 0 1,000 180 000 16 380

period
Solution 18.8
a) Receipt of invoice for audit work

i. This is an event after reporting period that is an adjusting event.
ii. It provides extra information relating to the measurement of the audit work completed at
31 December 20X3 (there is an event, being the audit work completed, which results in an
obligation to pay a bill; since the work was done before year-end, the event is a past event and
therefore the obligation is a present obligation at year-end).
iii. A current liability for C80 000 (80% completed by year end) in respect of audit fees must be
recognised at 31 December 20X3.
Debit Credit
Audit fee expense (80% x C100 000) 80 000
Audit fee payable 80 000
Audit fees for audit work performed before year end
b) Insolvent debtor
i This is an event after reporting period that is an adjusting event.
ii The event is the vandalism. Since the vandalism that caused the insolvency occurred before
year-end (December 20X3), the event is a past event. The announcement therefore provides
information regarding a condition that was already in existence at year-end. The measurement
of the asset (debtors) at year-end must therefore be adjusted.
iii The adjustment: the debtor’s balance needs to be written down by C80 000 in 20X3.
(C100 000 – C100 000 x 0.20).
Debit Credit
Bad/ doubtful debt expense 80 000
Accounts receivable 80 000
Doubtful debt written off
c) Drop in value of investment in shares

i This is an event after reporting period that is a non-adjusting event.
ii The event causing the drop in value was the outbreak of war. Since the war broke out after the
end of the reporting period, the event is not a past event.
iii Since the drop in value is material, the drop in the value of the investment should be disclosed
since this will affect the users’ decision making.
d) Issue of shares
i No adjustment is required.
ii The share issue will take place (10 May 20X4) after the financial statements are authorised for
issue (5 May 20X4) and therefore after the period between the end of the reporting period and
the date when the financial statements are authorised for issue.
iii The issue would therefore not be recognised or disclosed in the financial statements for the year
ended 31 December 20X3.

period
Solution 18.9
a) Warning by the lawyers
Issue
The issue is whether the warning is to be recognised as a provision or not recognised but disclosed as a
contingent liability.
Definitions
A contingent liability is:
• 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 entity; or
• a present obligation that arises from past events but is not recognised because:
- it is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation; or
- the amount of the obligation cannot be measured with sufficient reliability.
Discussion
• there is a possible obligation – no further cases have yet been brought against the company and
therefore there is no present obligation.
• there is a past event – poisoning of the long-life milk that leads to the guilty plea in the court case.
• The possible obligation will only be confirmed when the verdict is published and more potential
cases may be brought against Moo Limited. At present it is impossible to estimate the number of
cases or their financial impact.
The warning from Moo Limited’s lawyers that there may be more similar cases brought against the
company is a contingent liability. This would be disclosed in the notes but would not be recognised as
a liability. The nature of the contingent liability and the fact that an estimate is not possible would need
to be disclosed.
b) Estimated costs
Issue
The issue is whether the estimated costs are to be treated as an adjusting or non-adjusting event after
the reporting period.
Definitions
Events after the reporting period are those events, favourable and unfavourable, that occur between the
end of the reporting period and the date when the financial statements are authorised for issue.
Two types of events can be identified:

• those that provide evidence of conditions that existed at the end of the reporting period (adjusting
events after the reporting period); and
• those that are indicative of conditions that arose after the reporting period (non-adjusting events
after the reporting period).
Discussion
The estimations by the lawyers as to the settlement costs are an adjusting event as they give additional
information useful in estimating the obligation that was already in existence at year-end.

period
Solution 18.9 continued …
b) Estimated costs continued …
A provision for settlement costs must be recognised in the financial statements for the year ended
31 December 20X2 since:
• there is a present obligation as the court proceedings have indicated that Moo Limited is responsible
for the poisoning
• there is a past event, being the poisoning of the customer
• the expected result is an out-of-court settlement of C220 000 (the lower of the two estimated costs,
being what Moo Limited would rationally pay at the end of the reporting period).
Although an estimate has been made (a settlement of C220 000), there is a high degree of estimation
and the timing of these payments is uncertain. Therefore, assuming that these estimates are considered
to be reliable, these amounts should be recognised in the statement of financial position but disclosed
separately under liabilities as a provision.
(Note that if the estimates were not considered to be reliable, a contingent liability would have to be
disclosed in the notes).
c) Findings by the specialists
The findings of the specialists in January 20X3 are an adjusting event since the inventory on hand at
year-end was already poisoned and because this finding came about before the financial statements
were authorised for issue on 15 February 20X3.
The inventory that is contaminated must be written down to zero:

• C5 000 x 50% (on hand) = C2 500 write-down is required;
d) Possible returns
The possible returns of further long-life milk seem remote and therefore there is no need to either
disclose or recognise a liability of any kind.

period
Solution 18.10
The issue here relates to the accounting treatment of the court case, initially being disclosed as a
contingent liability and subsequently being recognised and disclosed as a liability in the published
financial statements.
a) Draft financial statements prepared at end December 20X3
A contingent liability is defined as

• a possible obligation that arose 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 entity; or
• a present obligation that arose from past events but is not recognised because the outflow of
resources is not probable or the amount cannot be reliably measured.
In the draft financial statements prepared at 31 December, the estimated costs of C100 000 should be
disclosed as a contingent liability
• there is a possible obligation (potential settlement costs and legal fees)
• that arose from past events (legal action against the company)
• whose existence will be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events (the outcome of the court case)
• Not wholly within the control of the company (outcome decided by the court)
(IAS 37.10)
A contingent liability is not recognised in the financial statements, but is disclosed, unless the possibility
of an outflow of economic resources is remote.
(IAS 37.27; IAS 37.28)
Disclosure is required at the end of the reporting period, giving details of

• a brief description of the nature of the contingent liability and, where practicable:
• an estimate of its financial effect
• an indication of the uncertainties relating to the amount or timing of any outflow
• the possibility of any reimbursement
(IAS 37.86)
b) Final financial statements prepared at end February 20X4
Events after the reporting period are events that occur between the end of the reporting period and the
date when the financial statements are authorised for issue.
• Adjusting events, that provide evidence of conditions that existed at the end of the reporting period
• Non-adjusting events, that are indicative of conditions that arose after the reporting period
(IAS 10.3)
The judgement on 5 February 20X4 is an adjusting event as it provides evidence of a condition that
existed at the end of the reporting period (the court case that was already in existence at the end of the
reporting period)
The contingent liability that was to be disclosed must instead now be recognised as a liability since the
possible obligation now becomes an actual obligation and thus meets the definition of a liability.
It is recognised as a ‘pure’ liability and is not recognised as a provision since neither the amount nor
the timing is uncertain.
An amount of C135 000 (C125 000 + C10 000) is disclosed as a current liability in the financial
statements at 31 December 20X3.

18 Provisions, Contingencies and EARP s22 - Final

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18 Provisions, Contingencies and EARP s22 - Final

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Solutions to GAAP : Graded Questions Provisions, contingencies and events after the reporting

Which of the following statements are correct?

1. A provision is a liability for which the amount is estimated.

a) Established pattern of past practice

Legislation creates a legal obligation under IAS 37.

A provision is the same as an accrual.

© Service & Kolitz, 2022 2023 Chapter 18: Page 1

Solution 18.1 continued . . .

Which of the following statements are correct?

a) 2, 3 and 4 are correct

© Service & Kolitz, 2022 2023 Chapter 18: Page 2

A provision recognised when

A constructive obligation is an obligation that derives from an entity’s actions where:

a) Is there a present obligation as a result of a past obligating event at 31 December 20X2?

b) Is there a present obligation as a result of a past obligating event at 31 December 20X3?

Fitting of the smoke reduction filters

© Service & Kolitz, 2022 2023 Chapter 18: Page 3

Solution 18.2 continued . . .

Is there an outflow of resources embodying economic benefits in settlement?

© Service & Kolitz, 2022 2023 Chapter 18: Page 4

A provision is defined as a liability of uncertain timing or amount. IAS 37.10

A provision is recognised when

Need to determine if there is a present obligation as a result of a past obligating event

An entry should be recorded to reverse the existing provision

Environmental cleaning costs

Need to determine if there is a present obligation as a result of a past obligating event

© Service & Kolitz, 2022 2023 Chapter 18: Page 5

a) Initial recognition of the previous major inspection

IAS 16 recognition criteria:

Depreciation (E) 16 375

© Service & Kolitz, 2022 2023 Chapter 18: Page 6

Solution 18.4 continued . . .

c) Recognition of the future inspection

A provision is defined as a liability of uncertain timing or amount.

A provision is recognised when

Provision for the future major inspection

© Service & Kolitz, 2022 2023 Chapter 18: Page 7

Cost of disposal of medical waste:

Penalty in respect of delayed disposal of medical waste:

© Service & Kolitz, 2022 2023 Chapter 18: Page 8

Solution 18.5 continued…

PARK HOSPITALS LIMITED

© Service & Kolitz, 2022 2023 Chapter 18: Page 9

For Parts A, B and C

The compensation meets the definition of a liability:

© Service & Kolitz, 2022 2023 Chapter 18: Page 10

Solution 18.6 continued

It also satisfies the recognition criteria for a liability:

© Service & Kolitz, 2022 2023 Chapter 18: Page 11

Solution 18.6 continued

© Service & Kolitz, 2022 2023 Chapter 18: Page 12

a) Accounting treatment for decommissioning costs

• An entity has a present obligation (legal or constructive) as a result of a past event.

© Service & Kolitz, 2022 2023 Chapter 18: Page 13

Solution 18.7 continued . . .

10-12/ X0 Plant: cost (A) 263 220

01/01/X1 Plant & machinery: decommissioning: cost (A) 111 780

31/12/X1 Finance costs 11 160