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IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Home Level 2 2.1 Financial Reporting Archive by Category "IAS 37 Provisions, Contingent Liabilities and Contingent Assets"

Category: IAS 37 Provisions, Contingent Liabilities and Contingent Assets

2.1 Financial ReportingIAS 37 Provisions, Contingent Liabilities and Contingent AssetsLevel 2

Nov 2020 Q2 a.

Nkoso Ltd (Nkoso) is an agro-processing company which reports under International Financial Reporting Standards up to 31 December each year.

On 10 October 2019, Nkoso organised a Christmas party at the company’s head office in Accra. Unfortunately, there was an incident of food poisoning and the company has received 500 legal claims from victims of the food poisoning, seeking compensation of an average of GH¢5,000 each. A letter from Nkoso’s legal advisors, dated 10 December 2019, suggests 40% of these claims are likely to be successful.

The Accountant of Nkoso does not want to make any provision for these claims on the grounds that less than 50% of the cl aims are likely to be successful. The legal advisors have suggested that an average of two years from the end of the current reporting period will elapse before the claims are settled. The risk related discount rate is estimated to be 10%.

Required:
In accordance with IAS 37: Provisions, Contingent Liabilities and Contingent Assets, advise the directors of Nkoso on the appropriate accounting treatment of the above in the financial statements for the year ended 31 December 2019.  (6 marks)

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The food poisoning claims are covered by IAS 37 Provisions, Contingent Liabilities and Contingent Assets. If there was a single claim, then it would be classified as a contingent liability, and no provision should be recognised in the SFP. This is because the outcome is possible not probable.

However, because there are 500 claims and each one has a 40% chance of succeeding, then overall Nkoso would expect to lose 200 claims. Therefore, a provision should be recognised in the SFP because:

  • There is an obligation at the end of the reporting period due to a past event
  • There is a probable outflow of economic resources
  • A reliable estimate can be made (200 claims at GH¢5,000 each)

Because the claims are not expected to be settled for another two years, the provision should be discounted using the risk related time value of money. The provision should therefore be carried in the SFP at 31 December at:
500 X 5,000 X 0.40 X 1/(1.10)2 = GH¢826,446

.                                                                                      GH¢m             GH¢m
Dr SPLOCI (retained earnings)                                        0.8
Cr Provisions (NCL)                                                                                0.8

Explanation of the treatment in IAS 37 or provisions and contingent liabilities, stating the conditions: 2 marks
Amount of provision to be recognized taking into consideration the discount rate 2 marks
Journal entries for the provision 2 marks

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3.1 Corporate ReportingIAS 10 Events after the Reporting PeriodIAS 37 Provisions, Contingent Liabilities and Contingent AssetsIFRS 5 Non-Current Asset held for sale and discontinued operationsLevel 3

Nov 2018 Q2 a.

Builsa Ltd (Builsa) is a listed company which assemble personal computers (PCs) and it is preparing its financial statements for the year ended 31 May 2018.

Builsa plans to close down one of its divisions. This division, which is classified as a separate
business segment, will cease all of its activities on 31 July 2018. Most of the assets of the business will be redeployed elsewhere in Builsa’s business, however some smaller items of plant will be sold off or scrapped. Approximately half of the staff of the division will be made redundant and they were notified of the decision in late May 2018. Customers and suppliers
were notified at the same time. The annual 2018 financial statements are scheduled to be released to the markets on 9 August 2018.

Required:
Advise the directors as to the financial reporting issues arising from the above matters and explain the appropriate treatment in Builsa’s financial statements in each case.                                                                                                                          (6 marks)

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IFRS 5
• The issue here is whether the closure of the division should be accounted for as a discontinued operation under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. A discontinued operation is defined as ‘a component of an entity that either has been disposed of or is classified as held for sale and:
a) represents a separate major line of business or geographical area of operations, or
b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations, or
c) is a subsidiary acquired exclusively with a view to resale.’
• As the discontinued operation has not been disposed of at the year end, it can only be classified as discontinued in the 2018 financial statements if it meets the definition of ‘held for sale’. Disposal groups are classified as held for sale if ‘their carrying amount will be recovered principally through a sales transaction rather than through continuing use’.
• This is not the case here as most of the assets are being redeployed elsewhere in the business.
• The small assets could potentially be classified as held for sale if all the relevant criteria, but not as a discontinued operation.

IAS 37
• Provision should be made for a redundancy costs if a constructive obligation exists at the year end. This appears to be the case as, assuming a detailed formal plan for the restructuring has been made, and the entity has raised a valid expectation in those
affected that the restructuring will be carried out by notifying them of the redundancy before the year end.

IAS 10
• As the annual financial statements were not scheduled to be released until after the closure of the division, the closure should be disclosed as a non-adjusting event after the reporting period due to its significance to the business (it is a separate operating
segment).                                                                                                        (3 points for 6 marks)

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2.1 Financial ReportingIAS 37 Provisions, Contingent Liabilities and Contingent AssetsLevel 2

May 2017 Q2 ai.

Akakpo Ltd obtained a license free of charge from the government to dig and operate a gold mine. Akakpo Ltd spent GH¢6 million digging and preparing the mine for operation and erecting buildings on site. The mine commenced operations on 1 September 2014. The license requires that at the end of the mine’s useful life of 20 years, the site must be reclaimed, all buildings and equipment must be removed and the site landscaped. At 31 August 2015, Akakpo Ltd estimated that the cost in 19 years’ time of the removal and landscaping will be GH¢5 million and its present value is GH¢3 million.
On 31 October 2015, there was a massive earthquake in the area and Akakpo Ltd’s mine shaft was badly damaged. It is estimated that the mine will be closed for at least six months and will cost GH¢1 million to repair.
Required:
Demonstrate how Akakpo Ltd should record the cost of the site reclamation as at 31 August 2015 in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.                                                                                               (3 marks)

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IAS 37 Provisions, contingent liabilities and contingent assets requires that future costs of reinstatement be provided for as soon as they become an unavoidable commitment. The mine’s license requires the work to be done, so there is a commitment as soon as the mine starts operations. The present value of the full cost must be provided for. GH¢ 3 million will be credited to provisions and added to the cost of the non-current asset.

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