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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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21.6 Contingent liabilities
21.6.1 Extract from FRS 102 – Section 21.12
21.12 A contingent liability is either a possible but uncertain obligation or a present obligation that is not recognised because it fails to meet one or both of the conditions (b) and (c) in paragraph 21.4. An entity shall not recognise a contingent liability as a liability, except for provisions for contingent liabilities of an acquiree in a business combination (see paragraphs 19.20 and 19.21). Disclosure of a contingent liability is required by paragraph 21.15 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.
21.6.2 OmniPro comment
21.6.2.1 Contingent liability – definition and when it arises (as stated in Section 21.12 of FRS 102).
See Liability decision tree at 21.6.2.2. A contingent liability is defined in Appendix 1 of FRS 102 as:
- ‘a present 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 reassured with sufficient reliability.’
Where a contingent liability exists where it is possible that there will be an outflow of economic benefits then a disclosure is required in the financial statements. Where the likelihood is considered remote no disclosure is required.
As discussed earlier, it may be unusual to conclude where an estimate cannot be determined given the possibility of using probabilities etc. In trying to assess the liability the entity should consult with experts e.g. solicitors to determine whether those parties can determine the expected out flow.
In reality, a contingent liability will arise:
- where it is possible but not probable (probable being more likely than not) for a future outflow of economic circumstances unless the possibility is remote in which case no disclosure is required.
- A present obligation may have occurred but it can only be determined on occurrence or non-occurrence of a future event
- the future outflow cannot be reliably measured
Where initially an entity has determined a contingent liability existed, the entity should continuously review the facts and circumstances and where it then emerges that a provision is required at that time, this is merely a change in estimate and a provision posted from that date. Section 32 of FRS 102 makes it clear that circumstance since year end but before the signing of financial statement should be reviewed to provide further evidence on provisions.
21.6.2.1.1 Exception to non-recognition of contingent liabilities
The only exception to non-recognition of contingent liabilities is the case where contingent liabilities are acquired in a business combination.
21.6.2.2 Table 1 – Liability Decision Tree
21.6.2.3 Contingent liability examples
Example 17: Contingent liability – remote
An employee has taken a case against Company A for unfair dismissal. At year end management have consulted with its legal advisor who believe the possibility of the employee succeeding with the case is remote.
Here there is a present obligation (i.e. the obligation to possibly compensate the employee) as a result of a past event (i.e. the dismissal of the employee) but the likelihood of outflow of economic benefits is remote i.e. not probable. In this particular case, no disclosure is required.
Example 18: Contingent liability – possible
Company A is an insurance underwriter that earns profit commission from insurance companies based on the number of claims made on policies that it has arranged for the insurance company. The commissions recognised can change in future years depending on the future loss ratios in relation to unsettled claims. Given the fact that the ratios can change year on year, the directors believe that it is not possible to estimate any future liabilities. On this basis although it is probable that there will be future economic outflows/inflows, and although there is a present obligation as a result of a past event (i.e. the recognising of commissions year on year), these cannot be measured reliably hence it is appropriate to disclosure these as a contingent liability.
Example 19: Contingent liability – occurrence or non-occurrence of future events/non ability to estimate liabilities
Company A is an insurance underwriter that earns profit commission from insurance companies based on the number of claims made on policies that it has arranged for the insurance company. The commissions recognised can change in future years depending on the future loss ratios in relation to unsettled claims. Given the fact that the ratios can change year on year, the directors believe that it is not possible to estimate any future liabilities. On this basis although it is probable that there will be future economic outflows/inflows, and although there is a present obligation as a result of a past event (i.e. the recognising of commissions year on year), these cannot be measured reliably hence it is appropriate to disclosure these as a contingent liability.
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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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