CHAPTER 48: PROVISION

QUESTION 48 – 1:
What do you understand by the term provision?
ANSWER:
A provision is an existing liability of uncertain timing or uncertain amount.
The essence of an provision is that there is uncertainty about the timing or amount of the future
expenditure.
Actually, a provision may be the equivalent of an estimated liability or a loss contingency that is accrued
because it is both probable and measurable.

QUESTION 48 – 2:
What are the conditions for the recognition of a provision as liability?
ANSWER:
PAS 37, paragraph 14, states that a provision shall be recognized as liability under the following
conditions:
a. The entity has a present obligation as a result of a past event.
b. It is probable that an outflow of economic benefits shall be required to be settle the obligation.
c. The amount of the obligation can be measured reliably.

QUESTION 48 – 3:
What is a present obligation?
ANSWER:
The present obligation may be legal or constructive.
It is fairly clear what a legal obligation is.
A legal obligation is an obligation arising from a contract; legislation or other operation of law.
A constructive obligation is an obligation that is derived from an entity’s actions where:
a. The entity has indicated to other parties that it will accept certain responsibilities by reason of an
established pattern of past practice, published policy, or a sufficiently specific current statement.
b. And as a result the entity has created a valid expectation on the part of other parties that it will
discharge those responsibilities.

QUESTION 48 – 4:
What is an obligating event?
ANSWER:
The past event that leads to a present obligation is called an obligating event.
An obligating event is an event that creates a legal or constructive obligation because the entity has no
reliable alternative but to settle the obligation created by the event.
This is the case where:
a. The settlement of an obligation can be enforced by law.
b. The event creates a valid expectation on the part of other parties that the entity will discharge the
obligation, as in the case of constructive obligation.

QUESTION 48 – 5:
Explain briefly probable outflow of economic benefits.
ANSWER:
For a provision to qualify for recognition, there must be not only a present obligation but also a probable
outflow of resources embodying economic benefits to settle the obligation.
An outflow of resources is regarded as probable if the event is more likely than not to occur. This means
that the probability that the event will occur is greater than the probability that the event will not occur.
As a rule of thumb, probable means more than 50% likely.

QUESTION 48 – 6:
Explain the measurement of provision.
ANSWER:
The amount recognized as a provision should be the best estimate of the expenditure required to settle
the present obligation at the end of reporting period.
The best estimate is the amount that an entity would rationally pay to settle the obligation at the reporting
period date or transfer it to a third party at a time.
Where a single obligation is being measured, the individual most likely outcome may be the best
estimate.
However, even in such a case, the entity shall consider other possible outcomes.
Where there is a continuous range of possible outcomes and each point in that range is as likely as any
other, the midpoint of the range is used.
Where the provision being measured involves a large population of items, the obligation is estimated by
“weighting” all possible outcomes of their associated possibilities.

QUESTION 48 – 7:
Enumerate certain considerations in the measurement of provision.
ANSWER:
 a. The risk and uncertainties that inevitably surround many events and circumstances shall be
taken into account in reaching the best estimate of a provision.

b. Where the effect of the time value of money is material, the amount of provision shall be the
present value of the expenditures required to settle the obligation.

c. Future events that affect the amount required to settle the obligation shall be reflected in the
amount of provision

d. Gains from expected disposal of assets shall not be taken into account in measuring a provision.

e. Where the expenditure required to settle a provision is expected to be reimbursed by another

party, the reimbursement shall be recognized when it is virtually certain that reimbursement will
be received.

The reimbursement shall be treated as separated asset and not “netted” against the estimated
liability for the provision. The amount shall not exceed the amount of the provision.

f. Provisions shall be reviewed at each reporting date and adjusted to reflect the current best
estimate.

g. A provision shall be used only for expenditures for which the provision was originally
recognized.

h. Provision shall not be recognized for future operating losses.

i. If an entity has an onerous contract, the present obligation under the onerous contract shall be
recognized and measured as a provision.

QUESTION 48 – 8:
What is restructuring?
ANSWER:
PAS 37, paragraph 10, defines restructuring as a program that is planned and controlled by management
and materially changes either the scope of a business of an entity or the manner in which that business is
conducted.
Examples of events that may qualify as restructuring include:
a. Sale or termination of a line of business
b. Closure of business location in a region of relocation of business activities from one location to
another
c. Change in management structure, such as elimination of a layer of management
d. Fundamental reorganization of an entity that has a material and significant impact of the
operations

QUESTION 48 – 9:
What is the amount of the restructuring provision?
ANSWER:
A restructuring provision shall include only direct expenditures arising from the restructuring. The
expenditures are necessarily entailed by the restructuring and not associated with ongoing activities of
the entity.
For example, salaries and benefits of employees to the incurred after operations cease and that are
associated with the closure of operations shall be included in the amount of restructuring provision.
PAS 37, paragraph 81, specifically excludes the following expenditures from the restructuring provision:
a. Cost of retraining or relocating continuing staff
b. Marketing or advertising program to promote the new entity image
c. Investment in new system and distribution network

QUESTION 48 – 10: MULTIPLE CHOICE (PAS 37)

1. What is the correct definition of a provision?
a. A possible obligation arising from past event.
b. A liability of uncertain timing or amount
c. A liability which cannot be easily measured
d. An obligation to transfer funds to an entity

2. A provision shall be recognized as liability when

a. An entity has a present obligation as a result of a past event
b. It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation
c. The amount of the obligation can be measure reliably
d. All of these are required for the recognition of a provision as liability

3. A legal obligation is an obligation that is derived from all of the following, except
a. Legislation
b. A contract
c. Other operation of law
d. An established pattern of past practices

4. A constructive obligation is an obligation

I. That is derived from an entity’s action that the entity will accept certain responsibilities
because of past practice, published policy or current statement.
II. The entity has created a valid expectation in other parties that it will discharge those
responsibilities.
a. I only
b. II only
c. Both I and II
d. Either I or II

5. It is an event that creates a legal or constructive obligation because the entity has no other realistic
alternative but to settle the obligation.
a. Obligating event
 b. Past event
c. Subsequent event
d. Current event

6. An outflow of resources embodying economic benefits is regarded as “probable” when

a. The probability that the event will occur is greater than the probability that the event will not
occur.
b. The probability that the event will not occur is greater than the probability that the event will
occur.
c. The probability that the event will occur is the same as the probability that the event will not
occur.
d. The probability that the event will occur is 90% likely.

7. When there is a continuous range of possible outcomes, and each point in that range is as likely as
any other, the range to be used is the
a. Minimum
b. Maximum
c. Midpoint
d. Sum of the minimum and maximum

8. When the provision involves a large population of items, the estimate of the amount
a. Reflects the weighting of all possible outcomes by their associated probabilities
b. Is determined as the individual most likely outcome
c. May be the individual most likely outcome adjusted for the effect of other possible outcomes
d. Midpoint of the possible outcomes

9. When the provision arises from a single obligation, the estimate of the amount
a. Reflects the weighting of all possible outcomes by their associated probabilities
b. Is determined as the individual most likely outcome
c. May be the individual most likely outcome adjusted for the effect of other possible outcomes
d. Midpoint of the possible outcomes

10. Which statement is incorrect where the expenditures required to settle a provision is expected to be
reimbursed by another party?
a. The reimbursement shall be recognized only when it is virtually certain that the
reimbursement would be received if the entity settles the obligation.
b. The amount of the reimbursement shall not exceed the amount of the provision
c. In the income statement, the expense relating to the provision may be presented net of the
reimbursement.
d. The reimbursement shall not be treated as separate asset but “netted” against the estimated
liability for provision.

QUESTION 48 – 11: MULTIPLE CHOICE (PAS 37)

1. Which statement is not true in relation to the measurement of provision?
a. The risk and uncertainties that inevitably surround many events and circumstances shall be
taken into account in reaching the best estimate of a provision.
 b. Where the effect of the time value of money is material, the amount of provision shall be the
present value of the expenditures required expected to settle the obligation
c. Future events that may affect the amount required to settle the obligation shall be reflected in
the amount of the provision where there is sufficient object objective evidence that the future
events will occur.
d. Gains from expected disposal of assets shall be taken into account in measuring a provision

2. Provisions shall be discounted if the effect of the time value of money is material. Which of the
following is incorrect regarding the discount rate?
a. Reflects current market assessment of the time value of money
b. Reflects risks specific to the liability
c. Does not reflect risks for which future cash flow estimates have been adjusted
d. Is a post – tax discount rate

3. Which statement is incorrect concerning recognition of a provision?

a. Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the
current best estimate
b. A provision shall be used only for expenditures for which the provision was originally
recognized
c. Provisions shall be recognized for future operating losses
d. If an entity has an onerous contract, the present obligation under the contract shall be
recognized and measured as a provision

4. It is a contract in which unavoidable costs of meeting the obligation under the contract exceed the
economic benefits to be received under the contract
a. Onerous contract
b. Executory contract
c. Executed contract
d. Sale contract

5. The unavoidable costs under an onerous contract represent the “least net cost exiting from the
contract” which is equal to
a. Cost of fulfilling the contract
b. Penalty arising from failure to fulfill the contract
c. Lower of the cost of fulfilling the contract or the penalty arising from failure to fulfill the
contract
d. Higher of the cost of fulfilling the contract or the penalty arising from failure to fulfill the
contract

QUESTION 48 – 12: MULTIPLE CHOICE (PAS 37)

1. This is defined as a structured program that is planned and controlled by management and materially
changes either the scope of a business of an entity or the manner in which that business is conducted
a. Restructuring
b. Liquidation
c. Recapitalization
d. Corporate revamp

2. Events that qualify as restructuring include all of the following, except

 a. Sale or termination of a line of business
b. Closure of business location in a region of relocation of business activities from one location
to another
c. Change in management structure, such as elimination of a layer of management
d. Fundamental reorganization of an entity that has an immaterial and insignificant impact of the
operations

3. Which is a cost of restructuring?

a. Cost of retraining or relocating continuing staff
b. Marketing or advertising cost
c. Investment in new system and distribution network
d. Cost of relocating business activities from one location to another

4. It is the abusive practice of manipulation and creative accounting by dumping all kinds of provisions
under the banner of provision for restructuring.
a. Big bath provision
b. Creative accounting
c. Cookie jar
d. General reserve

QUESTION 48 – 13: MULTIPLE CHOICE (IFRS)

1. For which of the following should a provision to be recognized?
a. Future operating losses
b. Obligations under insurance contracts
c. Reductions in fair value of financial instruments
d. Obligations for plant decommissioning costs

2. Provisions shall be recognized for all of the following, except

a. Cleaning – up costs of contaminated land when an oil entity has a published policy that it will
undertake to clean up all contamination closes
b. Restructuring costs after a binding sale agreement has been signed
c. Rectification costs relating to defective products sold
d. Future refurbishment costs due to introduction of a new computer system

3. An entity is closing one of its operating divisions, and the conditions for making restructuring
provision have been met. The closure will happen in the first quarter of the next financial year.

At the current year – end, the entity has announced the formal plan publicly and is calculating the
restructuring provision.

Which of the following costs should be included in the restructuring provision?

a. Retraining staff continuing to be employed
b. Relocation costs relating to staff moving to other divisions
c. Contractually required costs of retiring staff being made redundant from the division being
closed
d. Future operating losses of the division being closed up to the date of closure
4. An entity operates chemical plants. The published policies include a commitment to making good any
damage caused to the environment by the operations. The entity has always honored this
commitment.

Which of the following scenarios would give rise to an environmental provision?

a. On past experience it is likely that a chemical spill which would result in having to pay fines
and penalties will occur in the next year.
b. Recent research suggests there is a possibility that the entity’s action may damage
surrounding wildlife.
c. The government has outlined plans for a new law requiring all environmental damage to be
rectified
d. A chemical spill from one of the entity’s plants has caused harm to the surrounding area and
wildlife

5. An entity has been served a legal notice at year-end by the Department of Environment and Natural
Resources to fit smoke detectors in its factory on or before middle of next year. The cost of fitting
smoke detector can be measured reliably.

How should the entity treat this in financial statements at year-end?

a. Recognize a provision for the current year equal to the estimated amount
b. Recognize a provision for the current year equal to one-half only of the estimated amount
c. No provision is recognized at year-end because there is no present obligation for the future
expenditure since the entity can avoid the future expenditure by changing the method of
operations but disclosure is required.
d. Ignore the event.