Non-financial Liabilities, Provisions and Contingencies PDF

Preview

Summary

R I Z A L T E C H N O L O G I C A L U N I V E R S I T YCities of Mandaluyong and PasigLESSON 1NON-FINANCIAL LIABILITIES,PROVISIONSAND CONTINGENCIESI. Non-financial LiabilitiesA. Accrued Liabilities1. Premiums, Warranties, and Customer Loyalty Programs2. Payroll Taxes and Value Added Tax3. Liability ...

Description

RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig

LESSON 1

NON-FINANCIAL LIABILITIES, PROVISIONS AND CONTINGENCIES I. Non-financial Liabilities A. Accrued Liabilities 1. Premiums, Warranties, and Customer Loyalty Programs 2. Payroll Taxes and Value Added Tax 3. Liability for Bonuses 4. Refundable Deposits B. Unearned Revenues 1. Unearned Revenue on Sale of Goods and Services 2. Gift Certificates Payable II. Provisions: Definition, Measurement and Recognition III. Contingent Liabilities and Contingent Assets

Overview

This module is prepared for the students to understand the nature of provisions, contingencies and other current liabilities. This module discusses provisions, contingencies and other liabilities such as liabilities on premiums, warranties, customer loyalty programs, accrued liabilities (payroll taxes, VAT, gift certificates payable, liability for bonuses and refundable deposits) and unearned revenue; its characteristics, recognition and measurement (initial and subsequent) and presentation in the financial statements. This module will cover a brief discussion of the theory and standard behind the topic, exercises and practice problem the cover the said topic.

INTERMEDIATE ACCOUNTING PART 3 1

RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig

Study Guide

This module is designed for the students to understand non-financial liabilities, provisions and contingencies. This module includes: 1. Topic Discussions - to be read by the students to fully understand the topic. 2. Assessment – to be accomplished by the students after the discussion to test their skills and understanding to the subject matter. 3. Assignment – activity to be done by students to be submitted to the instructor. This is to reinforce or advance the student’s learning. It is relevant to the past, current, and future lessons. To complete the requirements of this module, the students are required to: 1. Read and understand the topic discussion and the guided exercises 2. Accomplish the assessment. 3. Accomplish the assignment due on next meeting.

Learning Outcomes At the end of the discussion, the students are expected to: 1. Account for the different non-financial liabilities and measure them for financial reporting. 2. Describe and distinguish provision from contingent liability and contingent assets, as well as other liabilities. 3. Describe the initial recognition, initial measurement, subsequent recognition, subsequent measurement, derecognition and financial statement presentation of provisions and contingencies. 4. Calculate the correct amount of provision and other current liabilities and its related accounts.

INTERMEDIATE ACCOUNTING PART 3 2 RIZALTECHNOLOGICALUNIVERSITY

Cities of Mandaluyong and Pasig

Topic Presentation LIABILITIES UNDER REVISED CONCEPTUAL FRAMEWORK A liability is a present obligation of the entity to transfer an economic resource as a result of past events. An obligation is a duty of responsibility that the entity has no practical ability to avoid. In accordance with recognition principled in the Conceptual Framework, an item of a liability is recognized in the financial statements if: a. It meets the definition of a liability; b. It provides useful information that is relevant and faithfully represented; c. The benefits from such information justify the cost of obtaining the information; and d. It is measurable Financial liabilities are contractual obligations: a. to deliver cash or another financial asset to another entity; b. to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity. Financial liabilities also include contracts that will or maybe settled in the entity’s own equity instruments and is: a. a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or b. a derivative that will or maybe settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity’s own equity instruments. Financial liabilities are initially recognized at cost, being the fair value of assets or services received in exchange for liabilities incurred, or when necessary, at the fair value of the liability incurred at the date of initial recognition. Liabilities that do not qualify with the characteristics above are classified as nonfinancial liabilities. NON-FINANCIAL LIABILITIES Non-financial liabilities are initially recognized and are subsequently measured at an assigned monetary amount, which in some instances, must be estimated. The use of estimates does not undermine the reliability of the financial statements. In other instances, the timing of the settlement such obligations may not be certain, as in obligations for product warranties, where customers are allowed to avail of the warranty within a specified period but not necessarily at a definite date. The uncertainty of the timing and/or the amount of the obligation does not disqualify the obligation to be recognized as accounting liabilities.

INTERMEDIATE ACCOUNTING PART 3 3 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig

PROVISIONS AND CONTINGENCIES IAS 37 Provisions, Contingent Liabilities and Contingent Assets is the standard that discusses the principles that covers provisions and contingencies. PROVISIONS Provisions are liabilities of uncertain timing or amount. Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast: a. trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and b. accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions. Accruals are often reported as part of trade and other payables, whereas provisions are reported separately. Recognition of Provisions An entity must recognize a provision if, and only if: a. a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event); b. an outflow of economic benefit to settle the obligation is probable (“more likely than not”); and c. the amount of the obligation can be estimated reliably. If these conditions are not met, no provision shall be recognized. The entry to record the provision is as follows: Expense xxx Estimated liability xxx To record the recognition of the provision CONTINGENT LIABILITIES A contingent liability is either a: a. possible obligation arising from past events whose existence will be confirmed only by the occurrence or non-occurrence of some uncertain future event not wholly within the entity’s control; or b. present obligation that arises from a past event but is not recognized 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 measured with sufficient reliability.

INTERMEDIATE ACCOUNTING PART 3 4 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig Recognition of Contingent Liabilities An entity shall not recognize a contingent liability.

A contingent liability is disclosed, unless the possibility of an outflow of resources embodying economic benefits is remote. Where 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. The entity recognizes a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made. Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognized in the financial statements of the period in which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be made). CONTINGENT ASSETS A contingent asset is a possible asset 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. Recognition of Contingent Assets An entity shall not recognize a contingent asset. Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the entity. An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain. Contingent assets are not recognized in financial statements since this may result in the recognition of income that may never be realized. However, when the realization of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate. A contingent asset is disclosed, where an inflow of economic benefits is probable. Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognized in the financial statements of the period in which the change occurs. If an inflow of economic benefits has become probable, an entity discloses the contingent asset. RELATIONSHIP BETWEEN PROVISIONS AND CONTINGENCIES In a general sense, all provisions are contingent because they are uncertain in timing or amount. However, within IAS 37 the term ‘contingent’ is used for liabilities and assets that are not recognized because their 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.

INTERMEDIATE ACCOUNTING PART 3 5 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig In addition, the term ‘contingent liability’ is used for liabilities that do not meet the recognition criteria.

Guidelines on Provisions and Contingencies To summarize, based on the foregoing discussion above, the following probabilities and scenarios are quantified to assess whether the contingency is recognized, disclosed or ignored: Probability

CONTINGENT LIABILITY

CONTINGENT ASSET

VIRTUALLY CERTAIN

More than 90%

Recognize (PROVISION)

Recognize (ASSET)

PROBABLE (more likely than not)

51% - 90%

Recognize (PROVISION)

Disclosure only.

POSSIBLE

5 % - 50%

Disclosure only.

Ignore.

REMOTE

Less than 5%

Ignore.

Ignore.

Illustration 1.1: Provisions and Contingent Liabilities Principles SPIDER-MAN Inc., a seller of novelty masks has had a lawsuit filed against it by DAILY BUGLE Mfg., Inc., another manufacturer of identical novelty masks. The suit alleges copyright infringements by SPIDER-MAN, Inc. and asks for compensatory damages. For the following situations, determine how SPIDER-MAN, Inc. should report the information concerning the lawsuit. The choices are: ACCRUE AND DISCLOSE, DISCLOSE ONLY, ACCRUE ONLY, or IGNORE. Situation

Answer

SPIDER-MAN’s legal counsel is convinced that the likelihood of losing the case is probable, the potential amount of the loss is estimated to be ₱ 10,000.

ACCRUE AND DISCLOSE

SPIDER-MAN’s legal counsel estimates that the infringement case will result in a loss of ₱ 400,000 but considers the likelihood of losing the case as remote.

IGNORE

SPIDER-MAN’s legal counsel estimates that the infringement case will result in a loss of ₱ 400,000 but considers the likelihood of losing the case reasonably possible.

DISCLOSE ONLY

SPIDER-MAN’s legal counsel is convinced that the likelihood of losing the case is probable, the potential amount of the loss, however, is currently undetermined.

DISCLOSE ONLY

Illustration 1.2: Provisions and Contingent Assets Principles SPIDER-MAN Inc., a seller of novelty masks, filed a lawsuit filed against DAILY BUGLE Mfg., Inc., another manufacturer of identical novelty masks. The suit alleges copyright infringements by DAILY BUGLE, Inc. and asks for compensatory damages. For the following situations, determine how SPIDER-MAN, Inc. should report the information concerning the lawsuit. The choices are: ACCRUE AND DISCLOSE, DISCLOSE ONLY, ACCRUE ONLY, or IGNORE.

INTERMEDIATE ACCOUNTING PART 3

6 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig Situation

Answer

SPIDER-MAN’s legal counsel is convinced that the likelihood of winning the case is probable, the potential amount of the loss is estimated to be ₱ 10,000.

DISCLOSE ONLY

SPIDER-MAN’s legal counsel estimates that the infringement case will result in a gain of ₱ 100,000 and considers the likelihood of winning the case as 100% certain. SPIDER-MAN’s legal counsel estimates that the infringement case will result in a loss of ₱ 400,000 but considers the likelihood of losing the case reasonably possible.

ACCRUE AND DISCLOSE IGNORE

MEASUREMENT OF PROVISIONS The amount recognized as a provision should be the BEST ESTIMATE of the expenditure required to settle the present obligation at the financial reporting date, taking into account the risk and uncertainties surrounding the circumstances that relate to the provision: a. EXPECTED VALUE (by weighing all possible outcomes by their associated probabilities) b. MIDPOINT (when there is continuous range of possible outcomes) c. PRESENT VALUE (for long-term provisions) Reimbursement Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognized when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognized for the reimbursement shall not exceed the amount of the provision. Restructuring A provision for restructuring costs is recognized only when the general recognition criteria for provisions are met. A restructuring provision shall include only the direct expenditures arising from the restructuring, which are those that are necessarily entailed by the restructuring and not associated with the ongoing activities of the entity. A restructuring provision does not include such costs as retraining or relocating continuing staff, marketing; investment in new systems and distribution networks. Illustration 2: Measurement of Provisions During 2020, MILES MORALES Inc. is the defendant in a patent infringement lawsuit. The lawyers believe that there is 10% chance that the court will dismiss the case and the entity will incur no outflow of economic benefits. However, the court rules in favor of the claimant, the lawyers believe that that there is 20% chance that the entity will be required to pay damages of ₱ 200,000 and an 80% chance that the entity will be required to pay damages of ₱ 100,000. Other outcomes are unlikely. The court is expected to rule in late December 2021. There is no

indication that the claimant will settle out of court.

INTERMEDIATE ACCOUNTING PART 3 7 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig A 12% risk adjustment factor to the probability-weighted expected cash flows is considered appropriate to reflect the uncertainties in the cash flow estimate. An appropriate discount is 3% per year. The present value of 1 at 3% for one period is 0.97. Probability of no outflow (10% * ₱ 0) ₱ 0 Probability to be liable {90% * [(200,000 * 20%) + (100,000 * 80%)] 108,000 Provision (undiscounted before adjustment) 108,000 Multiply by risk adjustment factor 1.12 Multiply by present value factor 0.97 Provision to be reported 117,331 ACCRUED LIABILITIES Accrued liabilities represent obligations, even when the legal or contractual commitment to pay has not yet been triggered. In other terms, these consists of obligations for expenses incurred on or before the end of the reporting period but payable at a later date. ESTIMATED LIABILITIES ON AFTER-SALES TRANSACTIONS These includes liabilities arising from events after a contract with customers happened, such as warranties, premiums, etc. PREMIUMS LIABILITY Premiums are articles of value such as goods or in some cases cash payments, given to customers as result of past sales or sales promotion activities. In order to stimulate the sales of their products, entities offer premium coupons to customers in return for product labels, box tops, wrappers and coupons. Premiums distributed to the customers are accounted for under IFRS 15 Revenue from Contracts with Customers. The transaction price at the date of sale is composed of the following: 1. Sales of goods that are sold outright to the customer; and 2. Liability for performance obligation that will be settled by the transfer of promised premium. Pro-Forma Journal Entries 1. Purchase of premium articles

Premiums Inventory/Prepaid Expense

xx x

Cash/Accounts Payable

2.

When premiums distributed customers

the are to

Premium Expense Premiums Inventory

xxx

xx x xxx

3. At the end of the year, if premiums are still outstanding

Premiums Inventory

xx x

Estimated Premium Liability

xxx

INTERMEDIATE ACCOUNTING PART 3 8 RIZALTECHNOLOGICALUNIVERSITY Cities of Mandaluyong and Pasig Illustration 3: Premium Liabilities GREEN GOBLIN Tech. launched a sales promotional program for its product by offering a limited-edition GREEN GOBLIN Grenade Replica (GGGR) for only ₱3.50 plus 10 product box tops returned. Past experience indicates that only 60% of the product box tops reaching the market will be redeemed: Relevant data follow: Number of boxes of product sold 1,000,000 Premiums: Purchased in cash GGGRs at₱ 50.00 per unit 50,000 Distributed to customers 30,000 The amount of premium expense is computed as total expected redemptions (in units) times net cost of premium. Total expected redemptions: 1,000,000 x 60% = 600,000; 600,000 ÷ 10 product box tops 60,000 Multiply by: Net cost of premiums (₱ 50 – 35) ₱ 15 Premium expense ₱ 900,000 Liability for outstanding premiums at year-end is computed as outstanding premiums (in units) time net cost of premium [(60,000 total expected redemptions less 30,000 actual redemptions) x ₱ 15] ₱ 450,000 Accounting entries to record the transactions above follow: 1

Premiums Inventory 2,500,000 Cash 2,500,000 To record the purchase of the premiums. (₱ 50 x 50,000 units) Premiums Expense 900,000 Estimated Premium Liability 900,000 To record liability for outstanding premium at the end of the reporting period. Cash 1,050,000 Estimated Premium Liability 450,000 Premiums Inventory 1,500,000 To record distribution of premium to customers. WARRANTY LIABILITY A warranty is a legal binding assurance that a product is, among other things fit for use as represented, free from defective material and workmanship, and meets statutory and/or other specifications. Warranty agreements require the seller to correct any deficiency ...