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Section 21: Provisions and Contingencies.
21.1.1 Extract from FRS 102 – Section 21.1-21.3.
21.1.2 OmniPro comment – Scope.
21.2 Initial recognition and subsequent measurement
21.2.1 Extract from FRS 102 – Section 21.4-21.11.
21.2.2.1 Conditions required to recognise a provision.
21.2.2.1.1 a) Present obligation as a result of a past event
21.2.2.1.1.1 Legal obligation.
21.2.2.1.1.2 Constructive obligation.
21.2.2.1.1.2.2 Refunds Policy.
21.2.2.1.3.1 Changes in income tax system.
21.2.2.1.3.2 Provision required for a future date.
21.2.2.1.3.3 Difficulty is assessing if a present obligation on a result of a past event exists.
21.2.2.1.3.4 Profits on disposal of fixed assets excluded.
21.2.2.1.3.5 Reimbursement by a third party for costs.
21.2.2.1.3.6 Weighted Probabilities.
21.2.2.1.2 b) Probability of transfer of economic benefits.
21.2.2.1.3 c) Obligation can be reliably measured.
21.2.2.1.4 Present value and the discount rate to be used.
21.2.2.1.5 Change in estimate and discount rates.
21.3.1. Extract from FRS 102 – Section 21.10-21.11A.
21.3.2 OmniPro comment – Onerous contracts.
21.4.1 Extract from FRS 102 – Section 21.11B.
21.4.1.1 OmniPro comment – Future operating losses.
21.5.1 Extract from FRS 102 – Section 21.11C-21.11D.
21.5.2 OmniPro comment – restructuring.
21.5.2.1 Definition and examples.
21.5.2.2 Restructuring and a constructive/legal obligation.
21.5.2.2.1 Examples that illustrate a detailed restructuring plan.
21.5.2.2.2 Examples of items that may be included in restructuring provision.
21.5.2.2.3 Examples of items that may not be included in restructuring provision.
21.6.1 Extract from FRS 102 – Section 21.12.
21.6.2.1 Contingent liability – definition and when it arises.
21.6.2.1.1 Exception to non-recognition of contingent liabilities.
21.6.2.3 Contingent liability examples.
21.7.1 Extract from FRS 102 – Section 21.13.
21.7.2 OmniPro comment – Contingent assets.
21.8 Decommission costs/ reinstatement/dilapidation provision.
21.10.1 Disclosures about provisions.
21.10.1.1 Extract from FRS 102 – Section 21.14.
21.10.1.2 OmniPro comment – Disclosures about provisioning.
21.10.1.2.1 Extract from accounting policy note – Provisions.
21.10.1.2.2 Remediation provision/environmental provision accounting policies.
21.10.1.2.3 Extract from notes to the financial statements – Provisions.
21.10.2 Disclosures about contingent liabilities.
21.10.2.1 Extract from FRS 102 – Section 21.15.
21.10.2.2 OmniPro comment – Contingent liability disclosures.
21.10.2.2.1 Accounting policy disclosure – Contingencies.
21.10.3 Disclosures about contingent assets.
21.10.3.1 Extract from FRS 102 – Section 21.16.
21.10.3.2.1 Accounting policy – Contingent assets.
21.10.4 Prejudicial disclosures.
21.10.4.1 Extract from FRS 102 – Section 21.17.
21.10.4.2 OmniPro comment – Prejudicial disclosures.
21.10.4.2.1 Extract from notes to the financial statements showing prejudicial disclosure.
21.10.5 Disclosure about financial guarantee contracts.
21.10.5.1 Extract from FRS 102 – Section 21.17.
21.10.5.2 OmniPro comment – Financial guarantee contract disclosures.
21.10.5.2.1 Financial guarantee contract example disclosures.
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21.3 Onerous contracts
21.3.1. Extract from FRS 102 – Section 21.10-21.11A
21.11A If an entity has an onerous contract, the present obligation under the contract shall be recognised and measured as a provision (see Example 2 of the appendix to this section)
21.3.2 OmniPro comment – Onerous contracts
Appendix 1 to FRS 102 defines an onerous contract as one in which the unavoidable costs of meeting the obligation under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract. This is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it. It is irrelevant as to whether an entity intends to make the cheapest choice or not, the least net cost is the only amount that should be provided for. The economic benefits to be considered are both the direct and indirect benefits.
Where such a contract exists the future operating losses on these contracts should be provided for as stated in Section 21.11A of FRS 102.
Example 10: Onerous lease
Company A entered into a lease on an office block in year 1 for a 10 year period for CU100,000 per annum. At the end of year 4, due to economic circumstances and reductions in staff the entity no longer has any use for the property and cannot sublease it but are contractually tied in for a further 6 years from that date. The company has discussed with the landlord as to the cost of terminating the lease early which they stated would be CU500,000.
As the entity is contractually committed to pay the lease, there is a present obligation as a result of a past event i.e. the signing of the contract to take on the lease for 10 years for which no further benefits will be obtained and a reliable estimate can be determined, a provision should be recognised for the lower of the cost to terminate of CU500,000 or the future lease amounts payable for 6 years of CU600,000. Therefore a provision should be recognised for CU500,000 and should be present valued where it is considered material.
Example 11: Onerous lease
Take example 10, and this time the entity can sublet the property for the remaining 6 years to a tenant for CU50,000 per annum. In this case a provision would be required for the amount by which the costs exceed the economic benefits which would be the amount net of sublease income which is CU300,000 present valued where material ((CU100,000-CU50,000)*6 years). Even if the premises has not been sublet by the end of year 6, the CU300,000 should still be used where it can be proven that there is a market for the property maybe through evidence provided by an auctioneer and there is evidence of the likely lease per annum that can be obtained. The income received from the sub-tenant would be shown as other income in the financial statements. The provision would be reduced year on year for the amount paid to the tenant in the year. The journals assuming present valuing was not required would be to:
| CU | CU | |
| Dr Provision | 50,000 | |
| Cr Rent Cost | 50,000 |
Being journal to reflect the reduction of the provision at each year end
| CU | CU | |
| Dr Rent Costs | 100,000 | |
| Cr Bank | 100,000 |
Being journal to reflect the payment of funds to the landlord
| CU | CU | |
| Dr Bank | 50,000 | |
| Cr Rental Income | 50,000 |
Being journal to reflect the receipt of funds from the subtenant.
Example 12: Onerous supply contract
Company A entered into a purchase contract with a supplier for 3 years (minimum amount of units to be ordered per annum is 50,000) at a time when supply of raw materials were scarce for a cost of CU10 per unit. A year later, the price for the same raw material was CU4, however the entity is contractually obliged to purchase a further 100,000 at a minimum from that supplier. The company can still sell the finished goods product which incorporates this part at the higher price at a profit of CU5.
Given that the entity makes a profit overall on the product there is no onerous contract so therefore no provision is required.
If we take the above example and this time assume that the product will be discontinued at the end of year 2 and during year 2, 40,000 finished goods will be sold incorporating the profit of CU5. Therefore in assessing whether an onerous contract exists there would be a need to take the net additional costs of the excess units of CU360,000 (60,000*(CU10-CU4) from the total profit from the sale of the 40,000 units in year 2 of CU200,000 (CU5 profit on finished good * 40,000 units). Therefore a provision should be made for the difference of CU160,000 at the end of year 1.
The same logic as example 12 would be applied to an onerous sales contract.
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Examples
Example 3: Staff retraining as a result of changes in the income tax system..
Example 4: Provision required for a future date.
Example 5: Court case where difficulty assessing whether present obligation exists.
Example 6: reimbursement by a third party.
Example 7: determining most likely outcome where a single obligation
Example 8: Estimating a provision.
Example 9: Present valuing a provision, change in estimate/cash flow and change in discount rate.
Example 12: Onerous supply contract
Example 13: Future operating losses.
Example 14: Closure of a division: no implementation before end of reporting period.
Example 15: Closure of a division: communication and implementation before end of reporting period.
Example 16: Restructuring provision – no formal plan.
Example 17: Contingent liability – remote.
Example 18: Contingent liability – possible.
Example 20: Contingent assets.
Example 21: Financial guarantees.
Example 22: Decommissioning reinstatement costs
Example 23: Reinstatement provision on property which is held on operating lease.
Example 24: Dilapidation requirement
Example 27: Extract from accounting policy and notes to the financial statements.
Example 28: Extract from accounting policy and notes to the financial statements.
Example 29: Extract from notes to the financial statements showing prejudicial disclosure.
Example 30: Extract from notes to the financial statements.
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