IFRS21.1 IAS 37 provides more guidance on accounting for restructurings.
© 2013 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
21 Provisions and contingencies |
17221.11 Onerous contracts (see paragraph 21.4 of this publication) are recognised and measured as a provision. [FRS102.21.11A]
21.12 A provision is recognised as a liability and as an expense unless the cost is required by FRS 102 to be recognised in the cost of an asset. [FRS102.21.5]
Measurement
21.13 A provision is measured at the best estimate of the amount required to settle the obligation at the reporting date. The best estimate is the amount an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. [FRS102.21.7]
21.14 When the provision involves a large population of items, the estimate of the amount reflects the weighting of all possible outcomes by their associated probabilities. When there is a continuous range of possible outcomes and each point on that range is as likely as any other, the mid-point of the range is used. [FRS102.21.7]
21.15 When the provision arises from a single obligation, the individual most likely outcome may be the best estimate of the amount required to settle the obligation. However, other possible outcomes are not ignored: when they are either mostly higher or mostly lower than the most likely outcome, the best estimate will be a higher or lower amount. [FRS102.21.7]
21.16 A provision is discounted to present value when the effect of discounting is material. A pre-tax discount rate is used to perform the discounting that reflects current market assessments of the time value of money. Either the discount rate or the estimated cash flows, but not both, are amended to reflect any risks specific to the liability. [FRS102.21.7] Example
For example, company A sells widgets with a three year warranty. Experience suggests that:
• 80% of widgets require no warranty repairs
• 10% require minor repairs (cost: 20% of sales price)
• 6% require major repairs (cost: 50% of sales price)
• 4% require replacement (cost: 70% of sales price)
Sales in 20X0 are £1m. Warranty costs are therefore estimated at £78k:
£1m x 80% x 0 = 0
£1m x 10% x 20% = £20k
£1m x 6% x 50% = £30k
£1m x 4% x 70% = £28k
Total £78k
The estimated timing of these warranty costs is as follows:
• 50% in 20X1
• 30% in 20X2
• 20% in 20X3
Assuming there are no other risks or uncertainties to be reflected, the present value of the expected cash flows for the warranty provision costs is as follows:
Year Expected cash (£k) Discount rate* Discount factor Present value (£k)
20X1 50% x £78k 39 4% 1/(1+0.04) = 0.962 38
20X2 30% x £78k 23 5% 1/(1+0.05)2 = 0.907 21
20X3 20% x £78k 16 6% 1/(1+0.06)3 = 0.840 13
Total 72
* Discount rate based on government bonds with the same term as the expected cash flows (4% for 1 year bonds, 5% for 2 year bonds, 6% for 3 year bonds)
173
| Cutting through UK GAAP
© 2013 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
21 Provisions and contingencies |
17421.18 Any gains from the expected disposal of assets are specifically excluded from the measurement of a provision. [FRS102.21.8]
21.19 If a reimbursement of some or all of the settlement of a provision is expected (e.g. through insurance), the
reimbursement is recognised only when it is virtually certain that the reimbursement will be received on settlement of the obligation. The reimbursement asset is not offset against the provision and is presented separately in the balance sheet. The reimbursement amount recognised cannot exceed the amount of the provision. In the income statement, the expense related to the provision may be shown net of any reimbursement income. [FRS102.21.9] 21.20 Only expenditure for which a provision was created is charged against that provision. [FRS102.21.10]
21.21 Provisions are reviewed at each reporting date and updated to reflect the current best estimate of the liability. Changes in the level of provision required are recognised in profit or loss unless recognised originally within the cost of an asset. For provisions discounted to present value, the periodic unwinding of the discount is recognised as a finance cost in profit or loss. [FRS102.21.11]
Contingent liabilities
21.22 A contingent liability is either a possible but uncertain obligation or a present obligation that is not recognised as a liability since it is either not probable that a transfer of economic benefits will occur, or the amount of economic benefit cannot be measured reliably. [FRS102.21.12]
21.23 Contingent liabilities are recognised as liabilities only when they are acquired in a business combination. Contingent liabilities are required to be disclosed unless the possibility of an outflow of resources is remote. When an entity is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability. [FRS102.21.12]
21.24 For example, company A has been sued by a customer but disputes the claim. Company A’s lawyers advise as at 31 December 20X0 that it is probable that company A will not be found liable. Company A does not therefore have a present obligation as a result of a past obligating event and does not recognise a provision. Assuming the probability of outflow is not deemed remote, the matter is disclosed as a contingent liability in the accounts. [FRS102.21A.9] Contingent assets
21.25 A contingent asset is a possible asset arising from past events whose existence will be confirmed by the occurrence of a future event not wholly in the entity’s control. [FRS102.21.13]
21.26 Contingent assets are not recognised as assets. Contingent assets are required to be disclosed when an inflow of economic benefits is probable. If an inflow of future economic benefits to the entity becomes virtually certain, the related asset is no longer a contingent asset, and an asset is recognised. [FRS102.21.13]
Disclosures
21.27 Disclosure of contingent liabilities includes a description of the contingency, an estimate of its financial effect, an indication of timing of expected outflow and any reimbursements expected. When it is impracticable to give this disclosure, that fact is stated. [FRS102.21.15]
21.28 Disclosure of contingent assets includes a description and an estimate of the financial effect. When it is impracticable to give this disclosure, that fact is stated. [FRS102.21.16]
21.29 In some extremely rare cases, the disclosures required by this section (including the disclosures required by FRS 102.21.14 for provisions that are not described here) might seriously prejudice the position of the entity in a dispute with other parties. In such cases the disclosure need not be given but instead a general description of the nature of the dispute and the reasons why the necessary disclosure has not been made are given. However, the seriously prejudicial exemption is not available to any UK company in respect of its provisions or contingent liabilities if that disclosure in respect of these items is required by the Companies Act. There would be no similar restriction on availability of the exemption for contingent assets since the Companies Act includes no disclosure requirements for contingent assets. See Schedule 1 paragraph 59 of the Regulations for the Companies Act disclosure requirements. [FRS102.21.17]