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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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21.5 Restructuring
21.5.1 Extract from FRS 102 – Section 21.11C-21.11D
21.11C A restructuring gives rise to a constructive obligation only when an entity:
(a) has a detailed formal plan for the restructuring identifying at least:
(i) the business or part of a business concerned;
(ii) the principal locations affected;
(iii) the location, function, and approximate number of employees who will be compensated for terminating their services;
(iv) the expenditures that will be undertaken; AND
(v) when the plan will be implemented; AND
(b) has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.
21.11D An entity recognises a provision for restructuring costs only when it has a legal or constructive obligation at the reporting date to carry out the restructuring.
21.5.2 OmniPro comment – restructuring
21.5.2.1 Definition and examples
FRS 102 – Appendix 1 defines a restructuring ‘as a programme that is planned and controlled by management and materially changes either:
- the scope of a business undertaken by an entity; OR
- the manner in which the business is conducted.
Examples of items that would come within the remit of a restructuring are:
- changes in management structure including redundancies of staff to so as to significantly reduce the cost base
- the sale or termination of a line of business
- the closure of business locations in a country or region
- fundamental reorganisations that have a material effect on the nature and focus of the entity’s operations.
21.5.2.2 Restructuring and a constructive/legal obligation
Section 21.11C of FRS 102 above details the requirements in order for a constructive obligation to have arisen before the balance sheet date – namely; where a formal plan is in place which identifies the business or part of the business concerned, the principal locations affected, the function and approximate number of employees who will be compensated, that expenditures will be undertaken and provide details of when the plan will be implemented.
The key requirement in order for a provision to be created is that:
- management have communicated their plans to affected parties prior to the year end date;
AND
- there is evidence to prove this.
For example, if a board meeting is held before the year end by management whereby they approved a significant restructuring which involved significant redundancies as a result of the closure of a product line but they have not communicated this to any of the outside/effected parties, then a provision cannot be made as they have not created a valid expectation to third parties, hence they could still pull out of the reorganisation as they could realistically withdraw.
21.5.2.2.1 Examples that illustrate a detailed restructuring plan
Examples which may prove the management have implemented a detailed restructuring plan are:
- communication to the parties affected by the restructuring whether that be a formal communication to employees as a whole or to employee representatives etc
- physically dismantling plant that is going to be scrapped/sold
- selling the excess assets as a result of the decision
- making public announcements of the plan
21.5.2.2.2 Examples of items that may be included in restructuring provision
The following are examples of items that could be included in restructuring provisions:
- voluntary redundancies which if not accepted will become mandatory
- compulsory redundancies
- lease cancellation fees for the premises being vacated due to the closure.
21.5.2.2.3 Examples of items that may not be included in restructuring provision
The following are examples of items that could not be included in restructuring provisions as they are determined to be costs of ongoing activities:
- relocation expenses of employees
- retraining of the remaining employees
- recruitment costs for new staff
- marketing costs to develop new marketing image
- investments in a new distribution network due to the closure of the old one
- relocation expenses
- Future operating losses up to the date of cessation and closure
- Impairment provision for warehouses etc. as these should be assessed for impairment in accordance with Section 27 of FRS 102
- Consulting fees to identify future corporate strategies or organisational structures
- Cost of relocating inventory and equipment that will be used in other factories/locations
- Cost of upgrading computer systems
Example 14: Closure of a division: no implementation before end of reporting period (Extracted from Section 21A.6 of FRS 102)
On 12 December 20X0 the board of an entity decided to close down a division. Before the end of the reporting period (31 December 20X0) the decision was not communicated to any of those affected and no other steps were taken to implement the decision.
Present obligation as a result of a past obligating event: There has been no obligating event, and so there is no obligation.
Conclusion: The entity does not recognise a provision.
Example 15: Closure of a division: communication and implementation before end of reporting period (Extracted from Section 21A.6 of FRS 102)
21A.7 On 12 December 20X0 the board of an entity decided to close a division making a particular product. On 20 December 20X0 a detailed plan for closing the division was agreed by the board, letters were sent to customers warning them to seek an alternative source of supply, and redundancy notices were sent to the staff of the division.
Present obligation as a result of a past obligating event: The obligating event is the communication of the decision to the customers and employees, which gives rise to a constructive obligation from that date, because it creates a valid expectation that the division will be closed.
An outflow of resources embodying economic benefits in settlement: Probable as it can be reliably measured.
Conclusion: The entity recognises a provision at 31 December 20X0 for the best estimate of the costs that would be incurred to close the division at the reporting date.
Example 16: Restructuring provision – no formal plan
Company A has approved a restructuring of its operations at a board meeting. They have made a formal announcement to all those effected parties. However management have a very general plan as to what locations are to be closed but no final decision has been made.
In this instance although they have a constructive obligation (i.e. the formal communication to the effected parties) they have not a detailed plan of action detailing which locations will be closed and the number of employees that will be made redundant. As there is no detailed plan as required by Section 21.C(a) a provision cannot be created at the year end.
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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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