CAF 7 – IAS 37

Provisions,
IAS 37 Contingent Liabilities &
Contingent Assets
02
Page | 1
LIABILITIES, PROVISIONS & CONTINGENCIES
A liability is a present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow of resources embodying economic benefits.
Provision Trade payables Accruals
A provision is a liability of trade payables are accruals are liabilities to pay for
uncertain timing or amount. liabilities to pay for goods or services that have been
goods or services that received or supplied but have not
Provisions can be have been received or been paid, invoiced or formally
distinguished from other supplied and have agreed with the supplier, including
liabilities such as trade been invoiced or amounts due to employees (for
payables and accruals formally agreed with example, amounts relating to
because there is uncertainty the supplier accrued vacation pay). Although it is
about the timing or amount sometimes necessary to estimate
of the future expenditure the amount or timing of accruals, the
required in settlement. uncertainty is generally much less
than for provisions.
Accruals are often reported as part of trade and other payables, whereas provisions
are reported separately.

THE TERM “PROVISION”

In some countries the term “provision” is also used to describe the reduction in the value of
an asset. For example accountants might talk of provision for depreciation, provision for
doubtful debts and so on. These “provisions” are not covered by this standard which is only
about provisions that are liabilities.

A present obligation arises if obligating event has happened.

An obligating event is an event that creates a legal or constructive obligation that results in
an entity having no realistic alternative to settling that obligation.
A legal obligation is an A constructive obligation is an obligation that derives from
obligation that derives from: an entity’s actions where:
(a) a contract (through its (a) by an established pattern of past practice, published
explicit or implicit policies or a sufficiently specific current statement,
terms); the entity has indicated to other parties that it will
(b) legislation; or accept certain responsibilities; and
(c) other operation of (b) as a result, the entity has created a valid expectation
law. on the part of those other parties that it will discharge
those responsibilities.

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 CAF 7 – IAS 37

A contingent liability is: A contingent asset is

(a) a possible obligation that arises from past events and a possible asset that
whose existence will be confirmed only by the occurrence arises from past events
or non-occurrence of one or more uncertain future events and whose existence
not wholly within the control of the entity; or will be confirmed only
Page | 2 (b) a present obligation that arises from past events but is not by the occurrence or
recognised because: non-occurrence of one
(i) it is not probable that an outflow of resources or more uncertain future
embodying economic benefits will be required to events not wholly within
settle the obligation; or the control of the entity.
(ii) the amount of the obligation cannot be measured
with sufficient reliability.

Note: in rare cases, it is not clear whether there is a present obligation. In these cases, a
past event is deemed to give rise to a present obligation if, taking account of all available
evidence, it is more likely than not that a present obligation exists at the end of the reporting
period.

SUMMARY OF ACCOUNTING TREATMENT

DEGREE OF PROBABILITY OBLIGATION ASSET
Certain [100%] Recognise a liability Recognise a normal asset
Virtually certain [86% to 99%] Recognise a liability Recognise a normal asset
Probable [50%+ to 85%] Recognise a provision Disclose a contingent asset
Possible [6% to 50%] Disclose a contingent liability Do nothing
Remote [l0 to 5%] Do nothing Do nothing

Latest update: March 2020

 CAF 7 – IAS 37

MEASUREMENT
Best The amount of provision shall be the best estimate of the expenditure
estimate (rationally) required to settle the present obligation at the end of year.
 Judgment of management
Possible
 Experience of similar transactions
determinants Page | 3
 Reports from independent experts
of estimate
 Additional evidence provided by events after the reporting period
The risks and uncertainties that inevitably surround many events and
Risk and
circumstances shall be taken into account in reaching the best estimate of a
uncertainties
provision.
Where the provision being measured
‘Expected value’ is used
involves a large population of items
Where there is a continuous range of
The mid-point of the range is
possible outcomes, and each point in
used
that range is as likely as any other.
The individual most likely
Where a single obligation is being
outcome may be the best
measured
estimate of the liability
The best estimate will be a higher
Dealing with or lower amount. For example, if
uncertainties an entity has to rectify a serious
fault in a major plant that it has
constructed for a customer, the
Where other possible outcomes are
individual most likely outcome
either mostly higher or mostly lower
may be for the repair to succeed
than the most likely outcome
at the first attempt at a cost of Rs.
1,000, but a provision for a larger
amount is made if there is a
significant chance that further
attempts will be necessary.
Tax impact The provision is measured at before tax amount.
Where the effect of the time value of money is material, the amount of a
Present
provision shall be the present value of the expenditures expected to be
value
required to settle the obligation.
The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s)
Discount current market assessments of the time value of money and the risks
rate specific to the liability. The discount rate(s) shall not reflect risks for which
future cash flow estimates have been adjusted.
Future events that may affect the amount required to settle an obligation
shall be reflected in the amount of a provision where there is sufficient
objective evidence that they will occur.
Future
events For example, an entity may believe that the cost of cleaning up a site at the
end of its life will be reduced by future changes in technology. However, an
entity does not anticipate the development of a completely new technology
for cleaning up unless it is supported by sufficient objective evidence.

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 CAF 7 – IAS 37

The effect of possible new legislation is taken into consideration in

measuring an existing obligation when sufficient objective evidence exists
that the legislation is virtually certain to be enacted.
Expected Gains from the expected disposal of assets shall not be taken into account
Page | 4 disposals in measuring a provision.

REIMBURSEMENT
Some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party.
The obligation for the amount The obligation for the
The entity has no expected to be reimbursed amount expected to be
obligation for the part of remains with the entity and it reimbursed remains with
the expenditure to be is virtually certain that the entity and the
reimbursed by the other reimbursement will be reimbursement is not
party. received if the entity settles virtually certain if the entity
the provision. settles the provision.
The reimbursement is
recognised as a separate asset
in the SFP.
The entity has no liability The expected reimbursement
It may be offset against the
for the amount to be is not recognised as an
expense in the SCI.
reimbursed. asset.
The amount recognised for the
expected reimbursement does
not exceed the liability.
The reimbursement is disclosed
together with the amount The expected reimbursement
No disclosure is required.
recognised for the is disclosed.
reimbursement
An obligation for which an entity is jointly and severally liable is a contingent liability to the
extent that it is expected that the obligation will be settled by the other parties.

CHANGES IN & USE OF PROVSIONS

Provisions shall be reviewed at the end of each reporting period and
Review
adjusted to reflect the current best estimate.
If it is no longer probable that an outflow of resources embodying economic
Reversal benefits will be required to settle the obligation, the provision shall be
reversed.
Change in Where discounting is used, the carrying amount of a provision increases in
present each period to reflect the passage of time. This increase is recognised as
value borrowing cost.
A provision shall be used only for expenditures for which the provision was
Use
originally recognised.

Latest update: March 2020

 CAF 7 – IAS 37

APPLICATION OF RULES TO SPECIFIC SITUATIONS

FUTURE OPERATING LOSSES
A reasonable expectation that carrying on trading / operations in future would result in loss.
These do not meet the definition of liability (as there is no present obligation);
Treatment
therefore, no provision is recognised.
Page | 5
Impairment An expectation of future operating losses is an indication that certain assets
indication of the operation may have been impaired.

FUTURE REPAIRS TO ASSETS

Some assets need to be repaired or to have parts replaced at intervals during their lives. For
example, suppose that a furnace has a lining that has to be replaced every five years. If the
lining is not replaced, the furnace will break down.
IAS 37 states that a provision cannot be recognised for the cost of future
repairs or replacement parts unless the company has an obligation to incur
the expenditure, which is unlikely. The obligating event is normally the actual
repair or purchase of the replacement part.

Instead of recognising a provision, a company should capitalise expenditure

incurred on replacement of an asset and depreciate this cost over its useful
Treatment life. This is the period until the part needs to be replaced again. For example,
the cost of replacing the furnace lining should be capitalised, so that the
furnace lining is a non-current asset; the cost should then be depreciated
over five years.

Normal repair costs, however, are expenses that should be included in profit
or loss as incurred.

ONEROUS CONTRACTS
It is a contract in which the unavoidable costs of meeting the obligations under the contract
exceed the economic benefits expected to be received under it.
The present obligation under the contract shall be recognised and measured
Treatment
as a provision
The unavoidable costs under a contract reflect the least net cost of exiting
Unavoidable
from the contract, which is the lower of the cost of fulfilling it and any
costs
compensation or penalties arising from failure to fulfil it.
Before a separate provision for an onerous contract is established, an entity
Impairment
recognises any impairment loss that has occurred on assets dedicated to
indication
that contract
WARRANTY CLAIMS
An entity provides warranty to its customers to repair or replace certain types of damage to
its products within a certain specific period following the sale date.
If the company can reasonably estimate the amount of warranty claims likely
Treatment to arise under the policy, it should accrue an expense that reflects the cost of
these anticipated claims.
The accrual should be recorded in the same reporting period in which the
Matching related product’s sales are recorded so that the financial statements
represent all costs associated with product sales most accurately.

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 CAF 7 – IAS 37

RESTRUCTURING
It is a programme planned and controlled by management, and materially changes either:
(a) the scope of a business undertaken by an entity; or
(b) the manner in which that business is conducted.
 sale or termination of a line of business;
Page | 6  the closure of business locations in a country or region or the
relocation of business activities from one country or region to another;
Examples  changes in management structure, for example, eliminating a layer of
management; and
 fundamental reorganisations that have a material effect on the nature
and focus of the entity’s operations.
A provision for restructuring costs is recognised only when the general
Treatment
recognition criteria for provisions are met.
A constructive obligation to restructure arises only when an entity:
(a) has a detailed formal plan for the restructuring
 the business or part of a business concerned;
 the principal locations affected;
When  the location, function, and approximate number of employees
constructive who will be compensated for terminating their services;
obligation  the expenditures that will be undertaken; and
arises  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.
If it is expected that there will be a long delay before the restructuring
Impact of begins or that the restructuring will take an unreasonably long time, it is
delayed unlikely that the plan will raise a valid expectation on the part of others
implementation that the entity is at present committed to restructuring, because the
timeframe allows opportunities for the entity to change its plans.
Only management or board decision to restructure taken before the end
Status of
of the reporting period does not give rise to a constructive obligation
management
unless implementation has been started or main features of the plan have
decision
been announced to those affected by it.
If an entity starts to implement a restructuring plan, or announces its main
Announcement
features to those affected, only after the reporting period, disclosure is
after year end
required under IAS 10 for a material non-adjusting event.
A restructuring provision shall include only the direct expenditures arising
Measurement - from the restructuring, which are those that are both:
Include (a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the entity.
A restructuring provision does not include such costs as:
(a) retraining or relocating continuing staff;
Measurement – (b) marketing; or
do not include (c) investment in new systems and distribution networks
(d) identifiable future operating losses up to the date of a restructuring
(e) gains on the expected disposal of assets

Latest update: March 2020

 CAF 7 – IAS 37

LOAN GUARANTEE
An entity may become surety (Guarantor) for loan granted to some other entity.
These are disclosed as contingent liabilities being possible obligation.
Treatment However, in case of default, possible obligation becomes present obligation
and a provision is to be recognised.
Page | 7
DECOMMISSIONING LIABILITIES AND SIMILAR LIABILITIES (DR&SL)
A company may be required to ‘clean up’ a location where it has been working when
production ceases.
A company has an obligation to ‘clean-up’ a site if:
Obligation  it is required to do so by law (a legal obligation); or
 its actions have created a constructive obligation to do so.
IAS 16 identifies the initial estimate of the costs of dismantling and removing
an item and restoring the site upon which it is located as part of the cost of an
asset. The asset is then depreciated.
Accounting
Treatment
Future clean-up costs often occur many years in the future so any provision
recognised is usually discounted to its present value and then re-measured
for changes in present value.

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 CAF 7 – IAS 37

IFRIC 1: CHANGES IN EXISTING DR&SL

INTRODUCTION
Under IAS 16, the cost of an item of property, plant and equipment includes
the initial estimate of the costs of dismantling and removing the item and
Page | 8 restoring the site on which it is located, the obligation for which an entity
incurs either when the item is acquired or as a consequence of having used
the item during a particular period for purposes other than to produce
Background inventories during that period.

IAS 37 contains requirements on how to measure DR&SL.

IFRIC 1 provides guidance on how to account for the effect of changes in the
measurement of existing DR&SL.
This Interpretation applies to changes in the measurement of any existing
DR&SL that is both:
(a) recognised as part of the cost of an item of PPE (IAS 16) or as part of
the cost of a right-of-use asset (IFRS 16); and
Scope (b) recognised as a liability in accordance with IAS 37.

For example, a decommissioning, restoration or similar liability may exist for

decommissioning a plant, rehabilitating environmental damage in extractive
industries, or removing equipment.
This Interpretation addresses how the effect of the following events that
change the measurement of an existing DR&SL should be accounted for:
(a) a change in the estimated outflow of resources embodying economic
benefits (e.g. cash flows) required to settle the obligation;
Issue (b) a change in the current market-based discount rate (this includes
changes in the time value of money and the risks specific to the
liability); and
(c) an increase that reflects the passage of time (also referred to as the
unwinding of the discount).

CONSENSUS: IF RELATED ASSET IS MEASURED USING COST MODEL

Cost of Subject to exception below, changes in the liability shall be added to, or
asset deducted from, the cost of the related asset in the current period.
Excess The amount deducted from the cost of the asset shall not exceed its carrying
decrease in amount. If a decrease in the liability exceeds the carrying amount of the
PL asset, the excess shall be recognised immediately in profit or loss.
If the adjustment results in an addition to the cost of an asset, the entity shall
consider whether this is an indication that the new carrying amount of the
asset may not be fully recoverable.
Impairment
indication
If it is such an indication, the entity shall test the asset for impairment by
estimating its recoverable amount, and shall account for any impairment loss,
in accordance with IAS 36.

Latest update: March 2020

 CAF 7 – IAS 37

CONSENSUS: IF RELATED ASSET IS MEASURED USING REVALUATION MODEL

Changes in the liability alter the revaluation surplus or deficit previously
recognised on that asset, so that:

(a) a decrease in the liability shall (subject to exception below) be

recognised in OCI and increase the revaluation surplus within equity, Page | 9
Revaluation except that it shall be recognised in PL to the extent that it reverses a
Surplus revaluation deficit on the asset that was previously recognised in PL;

(b) an increase in the liability shall be recognised in PL,

except that it shall be recognised in OCI and reduce the revaluation

surplus within equity to the extent of any credit balance existing in the
revaluation surplus in respect of that asset.
Excess In the event that a decrease in the liability exceeds the carrying amount that
decrease in would have been recognised had the asset been carried under the cost
PL model, the excess shall be recognised immediately in profit or loss.
A change in the liability is an indication that the asset may have to be
revalued in order to ensure that the carrying amount does not differ materially
from that which would be determined using fair value at the end of the
Revaluation
reporting period. Any such revaluation shall be taken into account in
indication
determining the amounts to be recognised in profit or loss or in other
comprehensive income as above. If a revaluation is necessary, all assets of
that class shall be revalued.
IAS 1 requires disclosure in the statement of comprehensive income of each
component of other comprehensive income or expense.
Disclosure
In complying with this requirement, the change in the revaluation surplus
arising from a change in the liability shall be separately identified and
disclosed as such.

CONSENSUS: COMMON ISSUES

The adjusted depreciable amount of the asset is depreciated over its
Changes in
useful life. Therefore, once the related asset has reached the end of its
liability after
useful life, all subsequent changes in the liability shall be recognised in
assets’ useful
profit or loss as they occur. This applies under both the cost model and the
life
revaluation model.
Periodic
The periodic unwinding of the discount shall be recognised in profit or loss
unwinding of
as a finance cost as it occurs. Capitalisation under IAS 23 is not permitted.
discount

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 CAF 7 – IAS 37

DISCLOSURES
The movement (comparative not required) shall be disclosed.
For each class  nature of obligation and expected timing of outflow;
of Provisions  indication of any uncertainties and major assumptions;
Page | 10  any expected reimbursement
 nature of contingent liability
For each class
 an estimate of financial effect, if practicable
of Contingent
 indication of uncertainties
liability
 possibility of any reimbursement
Contingent  nature of the contingent asset
asset  an estimate of financial effect, if practicable
Where any of the information required is not disclosed because it is not
Impracticability
practicable to do so, that fact shall be stated.

Illustrative example – Provisions and contingencies

Movement for each class of provisions
Damages Restoration Total
Rs. 000
Balance at beginning of year 10 20 30
Increase due to estimate change or new provisions 5 11 16
Provisions used (4) (6) (10)
Unused amounts reversed (1) - (1)
Increase due to passage of time 1 3 4
Balance at end of year 11 28 39

Narrative Disclosure - Provisions

Warranty Provisions - Situation: A manufacturer gives warranties at the time of sale to
purchasers of its three product lines. Under the terms of the warranty, the manufacturer
undertakes to repair or replace items that fail to perform satisfactorily for two years from the
date of sale. At the end of the reporting period, a provision of 60,000 has been recognised.
The provision has not been discounted as the effect of discounting is not material. The
following information is disclosed:

A provision of Rs. 60,000 has been recognised for expected warranty claims on products
sold during the last three financial years. It is expected that the majority of this expenditure
will be incurred in the next financial year, and all will be incurred within two years after the
reporting period. (IAS 37)

Decommissioning costs – Situation: In 2000, an entity involved in nuclear activities

recognises a provision for decommissioning costs of 300 million. The provision is estimated
using the assumption that decommissioning will take place in 60–70 years’ time. However,
there is a possibility that it will not take place until 100–110 years’ time, in which case the
present value of the costs will be significantly reduced. The following information is
disclosed:

A provision of Rs. 300 million has been recognised for decommissioning costs. These costs
are expected to be incurred between 2060 and 2070; however, there is a possibility that
decommissioning will not take place until 2100–2110. If the costs were measured based
upon the expectation that they would not be incurred until 2100–2110 the provision would be
reduced to Rs. 136 million. The provision has been estimated using existing technology, at
current prices, and discounted using a real discount rate of 2 per cent. (IAS 37)

Latest update: March 2020

 CAF 7 – IAS 37

Disclosures – Contingent Liabilities

There is a pending litigation against the company for damages of Rs. 20 million filed by
Customer alleging the defective performance by a company on two different contracts.
However, no provision has been recognised because company lawyers are confident that
the matter would be decided in company’s favour. Even if the claim turns out to be
successful, the insurance company shall reimburse 50% of the amount claimed. Page | 11

Disclosures – Contingent Assets

The company has filed a suit against one of its supplier for supplying faulty goods. The
amount of damages claimed is Rs. 35 million. The company lawyers are confident that the
company shall win the suit.

SYLLABUS

Reference Content/Learning outcome

IAS 37 Provisions, contingent liabilities and contingent assets (including

C4 IFRIC 1 changes in existing decommissioning, restoration and similar
liabilities)
Define liability, provision, contingent liability and contingent asset also describe
LO3.4.1
their accounting treatment.
LO3.4.2 Distinguish between provisions, contingent liabilities or contingent assets
LO3.4.3 Understand and apply the recognition and de-recognition criteria for provisions
Calculate/measure provisions such as warranties/guarantees, restructuring,
LO3.4.4 onerous contracts, environmental and similar provisions, provisions for future
repairs or refurbishments
Account for changes in provisions, decommissioning, restoration and similar
LO3.4.5
liabilities
LO3.4.6 Apply disclosure requirements for provisions.
Understand changes in the measurement of decommissioning and restoration
LO3.4.7
cost and similar liabilities
Proficiency level: 2
Testing level: 2

Past Paper Analysis

A14 S15 A15 S16 A16 S17 A17 S18 A18 S19 A19 S20
13 17 12 - 15 10 15 04 12 12 17 191
*This topic often involves implication of IAS 10 as well.
1
One question of 8 marks (including 3 marks on ethics) and another of 14 marks.

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 CAF 7 – IAS 37

PRACTICE Q&A
Sr.# Description Marks Reference
BASIC
1C Application to various scenarios 22 IAS 37
Page | 12 2C Measurement: Expected value 03 IAS 37
3C Measurement: Present value with future events 04 KA
4C Measurement: Virtually certain draft law 03 IAS 37
5C Measurement: Expected gains and impact on provision 03 KA
6C Impact of virtually certain reimbursement 03 KA
7C Review, reversal and use of provision 06 KA
APPLICATION OF RULES TO SPECIFIC SITUATIONS
8C Onerous contract – non-cancellable lease 04 IAS 37
9C Onerous contract – firm commitment contracts 05 KA
10C Restructuring 03 IAS 37
11C Restructuring 03 IAS 37
12C Restructuring – measurement 06 KA
IFRIC 1: Changes in existing DR&SL
13C Karim Limited – Decommissioning liability JEs 10 PE S17
14H Badar – Restoration provision 07 QB
15H Violet Power Limited – Change in DR&SL with cost model 12 QB
16H Faraz – Change in DR&SL with revaluation model 10 QB
17C Bravo - Change in DR&SL with cost model 12 QB
18C WML - Changes in DR&SL with revaluation model 16 QB
DISCLOSURES
19C MPL – Disclosure Notes with explanation 15 QB
VARIOUS ISSUES COMBINED
20H Five independent scenarios relating to IAS 37 15 QB
21H J-Mart Limited – six scenarios relating to IAS 37 15 QB
22C Quality Garments Limited – Various issues of IAS 37 13 PE A14
23C Zamil Limited – Various issues of IAS 10 and IAS 37 17 PE S15
24C ICL – Accounting treatment and disclosure requirements 12 PE A15
25C Neptune Limited – Impact on FS of two consecutive years 15 PE A16
26H Walnut – NRV, Restructuring, Theft, Share price, customer
15 QB
liquidation, dividend
27H Georgina – four issues 12 QB
28H Akber Chemicals Limited - Environmental provision, decline
12 QB
in demand, claims and reimbursement
29H QIL – Warranty, Onerous lease, Injury claims, penalty and
16 QB
reimbursement
30H Skyline Limited - Bankruptcy, fraud, contingent asset,
12 QB
damages
31C Naba Power Limited – Various issues 15 PE A17
32C Melon Limited – four different issues 12 PE A18
33H Rowsley – Various issues 15 QB
34C Oval Limited: Warranty, reimbursement, NRV 12 PE S19
35C Turquoise Limited: Probability, restructuring, Inventory and
17 PE A19
warranty with reimbursement

Latest update: March 2020

 CAF 7 – IAS 37

QUESTION 01
Briefly discuss the accounting treatment for each of the following situation under IAS 37. All
the entities in the question have 31 December year-ends. Assume that reliable estimate can
be made. (22)
1. A manufacturer gives warranties at the time of sale to purchasers of its product.
Under the terms of the contract for sale the manufacturer undertakes to make good,
Page | 13
by repair or replacement, manufacturing defects that become apparent within three
years from the date of sale. On past experience, it is probable (ie more likely than not)
that there will be some claims under the warranties.
2. An entity in the oil industry causes contamination and operates in a country where
there is no environmental legislation. However, the entity has a widely published
environmental policy in which it undertakes to clean up all contamination that it
causes. The entity has a record of honouring this published policy.
3. An entity operates an offshore oilfield where its licensing agreement requires it to
remove the oil rig at the end of production and restore the seabed. Ninety per cent of
the eventual costs relate to the removal of the oil rig and restoration of damage
caused by building it, and 10 per cent arise through the extraction of oil. At the end of
the reporting period, the rig has been constructed but no oil has been extracted.
4. A retail store has a policy of refunding purchases by dissatisfied customers, even
though it is under no legal obligation to do so. Its policy of making refunds is generally
known.
5. Under new legislation, an entity is required to fit smoke filters to its factories by 30
June 2011. The entity has not fitted the smoke filters. What is impact of this at 31
December 2010, the end of the reporting period?
6. Under new legislation, an entity is required to fit smoke filters to its factories by 30
June 2011. The entity has not fitted the smoke filters. What is impact of this at 31
December 2011, the end of the reporting period?
7. The government introduces a number of changes to the income tax system. As a
result of these changes, an entity in the financial services sector will need to retrain a
large proportion of its administrative and sales workforce in order to ensure continued
compliance with financial services regulation. At the end of the reporting period, no
retraining of staff has taken place.
8. After a wedding in 2010, ten people died, possibly as a result of food poisoning from
products sold by the entity. Legal proceedings are started seeking damages from the
entity but it disputes liability. Up to the date of authorisation of the financial statements
for the year to 31 December 2010 for issue, the entity’s lawyers advise that it is
probable that the entity will not be found liable.
9. Consider the same facts as given in 8 above. However, when the entity prepares the
financial statements for the year to 31 December 2011, its lawyers advise that, owing
to developments in the case, it is probable that the entity will be found liable.
10. A furnace has a lining that needs to be replaced every five years for technical
reasons. At the end of the reporting period, the lining has been in use for three years.
11. An airline is required by law to overhaul its aircraft once every three years.

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 CAF 7 – IAS 37

QUESTION 02
An entity sells goods with a warranty under which customers are covered for the cost of
repairs of any manufacturing defects that become apparent within the first six months after
purchase. If minor defects were detected in all products sold, repair costs of Rs. 850,000
would result. If major defects were detected in all products sold, repair costs of Rs.
4,500,000 would result. The entity’s past experience and future expectations indicate that,
Page | 14 for the coming year, 75 per cent of the goods sold will have no defects, 20 per cent of the
goods sold will have minor defects and 5 per cent of the goods sold will have major defects.

Required:
Calculate the amount of provision to be recognised in respect of warranty. (03)

QUESTION 03
X Limited has purchased and installed a plant at a total cost of Rs. 20 million on January 01,
2011. The plant has a useful life of 10 years. There is a legal requirement to restore the site
at the end of useful life. It is estimated that Rs. 5 million shall have to be incurred on 31
December 2020 using existing technology on the restoration. However, due to recent
development in technology it is estimated that actual cost of restoration on 31 December
2020 would be Rs. 3 millions only. The entity uses pre-tax discount rate of 10% wherever
applicable.

Required:
Calculate the amount of provision at its inception and pass the journal entry to record the
purchase and installation of the plant. (04)

QUESTION 04
An entity in the oil industry causes contamination but cleans up only when required to do so
under the laws of the particular country in which it operates. One country in which it operates
has had no legislation requiring cleaning up, and the entity has been contaminating land in
that country for several years. At 31 December 2010 it is virtually certain that a draft law
requiring a clean-up of land already contaminated will be enacted shortly after the year-end.
The cleaning up will cost Rs. 4 million. Discuss accounting treatment. (03)

QUESTION 05
Z Limited installed a plant costing Rs. 25 million with a useful life of 10 years. There is legal
requirement to restore the site used by the plant at the end of its useful life which shall cost
Rs. 1 million. The plant has residual value of Rs. 2 million and may be sold for Rs. 3.5 million
at the end of useful life. The assistant accountant is of the view that there is no need to
create the provision for restoration as this shall be adjusted against the expected gain on
disposal of the plant.

Required:
Comment on the statement made by the assistant accountant. (03)

QUESTION 06
A claim has been made against X Limited for damage suffered by adjacent property due to
work being undertaken on building of X Limited by a sub-contractor. The lawyers have
confirmed that X Limited will have to pay damages of Rs. 3 million but due to a clause in
agreement with sub-contractor will also be able to recover Rs. 2 million from the sub-
contractor.

Required:
Pass the journal entry for the above (03)

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 CAF 7 – IAS 37

QUESTION 07
Last year a damages claim (I) of Rs. 12 million was filed against the company. The lawyers
were of the opinion that it is probable to pay the damages of Rs. 12 million and therefore, the
company recognised the provision for this amount. The case has not been decided yet but
due to development in the case, the lawyers are of the opinion that the damages of Rs. 7
million will have to be paid only. Page | 15

Last year another claim (II) of Rs. 4 million was filed against the company. The lawyers were
of the opinion that it is probable to pay the damages of Rs. 4 million and therefore, the
company recognised the provision for this amount. During the year, the case has now been
decided in favour of the company. However, in another legal suit (III) against the company
(filed during the year) the company had to pay damages of Rs. 4 million.

Required:
Pass the journal entries for the above transactions. (06)

QUESTION 08
An entity operates profitably from a factory that it has leased under an operating lease.
During December 2010 the entity relocates its operations to a new factory. The lease on the
old factory continues for the next four years at Rs. 100,000 per annum, it cannot be
cancelled and the factory cannot be re-let to another user. The company uses 10% for
discounting to present value (cumulative annuity factor 3.1699). Discuss accounting
treatment. (04)

QUESTION 09
SK Limited is engaged in trading of chemical products and has entered into following two
contracts.
(a) On December 15, 2010 with ABC Limited to supply 1,000 units of Product A at Rs.
10 to be delivered on Jan 15, 2011. On December 31, 2010 SK Limited has 800 units
(at Rs. 9 per unit) of Product A in inventory and the purchase price of Product A has
increased to Rs. 12 per unit.

(b) On December 20, 2010 with XYZ Limited (a firm contract) to buy 500 units of Product
X at Rs. 10 to be delivered on Jan 20, 2011. On December 31, 2010 the purchase
price of Product X has fallen to Rs. 7 per unit.

Required:
Record journal entries due to change in purchase prices at December 31, 2010 the year-
end. (05)

QUESTION 10
On 12 December 2010 the board of an entity decided to close down a division. Before the
end of the reporting period (31 December 2010) the decision was not communicated to any
of those affected and no other steps were taken to implement the decision. (IAS 37)

Required:
Assuming that the reliable estimate is available, what will be accounting treatment for the
above? (03)

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 CAF 7 – IAS 37

QUESTION 11
On 12 December 2010, the board of an entity decided to close down a division making a
particular product. On 20 December 2010 a detailed plan for closing down 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. (IAS 37)
Page | 16 Required:
Assuming that the reliable estimate is available, what will be accounting treatment for the
above? (03)

QUESTION 12
Singh & Co has year-end of 30 June. On June 25, 2011 Singh & Co has decided to change
its management and operational structure in order to work efficiently and competitively. The
plan has been formally approved and announced to all major stakeholders. The
implementation shall start from August 31, 2011. The following costs are expected to be
incurred:
Include
(a) Shifting allowance to employees Rs. 500,000
(b) Consultant fee Rs. 700,000
(c) New computer and distribution network systems Rs. 1,500,000
(d) Staff training Rs. 50,000
(e) Advertisement of new and improved operations Rs. 120,000
(f) Implementation expenses specifically incurred for restructuring Rs.
450,000
(06)

QUESTION 13
Karim Limited (KL) bought a special purpose engineering plant on 1 January 2015 at a cost
of Rs. 1,755 million inclusive of sales tax @ 17% (refundable).

KL is required to decommission the plant after a period of 2 years. Decommissioning cost is

estimated at Rs. 300 million. The applicable discount rate is 11%.

KL uses the cost model for subsequent measurement of its property, plant and equipment.
Plant is being depreciated using the straight line method over its useful life.

Required:
Prepare journal entries to record the above transactions for the years 2015 and 2016.
(10)

QUESTION 14
The following information relates to the financial statements of Badar for the year to 31
March 2015.

The mining division of Badar has a 3 year operating licence from an overseas government.
This allows it to mine and extract copper from a particular site. When the licence began on 1
April 2014, Badar started to build on the site. The cost of the construction was Rs. 500,000.

The overseas country has no particular environmental decommissioning laws. In its past
financial statements Badar has given information about the company’s environmental policy
and has provided examples to demonstrate that it is a responsible company that believes in
restoring mining sites at the end of the extraction period. The cost of removing the
construction at the end of the three years is estimated to be Rs. 100,000. The cost of the site

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 CAF 7 – IAS 37

currently shown in the trial balance is Rs. 500,000. The company has a cost of borrowing of
10%.

Required
Explain the correct accounting treatment for the above (with calculations if appropriate).
(07)
Page | 17
QUESTION 15
Violet Power Limited is running a coal based power project in Pakistan. The Company has
built its plant in an area which contains large reserves of coal. The company has signed a 20
years agreement for sale of power to the Government. The period of the agreement covers a
significant portion of the useful life of the plant. The company is liable to restore the site by
dismantling and removing the plant and associated facilities on the expiry of the agreement.

Following relevant information is available:

(i) The plant commenced its production on July 1, 2015. It is the policy of the company
to measure the related assets using the cost model;
(ii) Initial cost of plant was Rs. 6,570 million including erection, installation and borrowing
costs but does not include any decommissioning cost;
(iii) Residual value of the plant is estimated at Rs. 320 million;
(iv) Initial estimate of amount required for dismantling of plant, at the time of installation
of plant was Rs. 780 million. However, such estimate was reviewed as of June 30,
2016 and was revised to Rs. 1,021 million;
(v) The Company follows straight line method of depreciation; and
(vi) Real risk-free interest rate prevailing in the market was 8% per annum when initial
estimates of decommissioning costs were made. However, at the end of the year
such rate has dropped to 6% per annum.

Required
Work out the carrying value of plant and decommissioning liability as of June 30, 2016.
(12)

QUESTION 16
Faraz is a chartered accountant and employed as Finance Manager of Gladiator Limited
(GL). He has recently returned after a long medical leave and has been provided with draft
financial statements of GL for the year ended 30 June 2017. Following figures are reflected
in the draft financial statements:
Rs. in million
Profit before tax 125
Total assets 1,420
Total liabilities 925

While reviewing the financial statements, he noted the following issues:

As at 30 June 2017, dismantling cost relating to a plant has increased from initial estimate of
Rs. 30 million to Rs. 40 million. Further, fair value of the plant on that date was assessed at
Rs. 112 million (net of dismantling cost). No accounting entries have been made in respect
of increase in dismantling liability and revaluation of the plant.

The plant had a useful life of 5 years when it was purchased on 1 July 2015. The carrying
value of plant and related revaluation surplus included in the financial statements are Rs.
135.4 million (after depreciation for the year ended 30 June 2017) and Rs. 3.15 million (after
transferring incremental depreciation for the year ended 30 June 2017) respectively.

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 CAF 7 – IAS 37

The appropriate discount rate is 8%.

Required:
Determine the revised amounts of profit before tax, total assets and total liabilities after
incorporating the impact of above adjustments, if any. (10)

Page | 18 QUESTION 17
The financial statements of Bravo Limited (BL) for the year ended 30 September 2013 are
under finalisation and the following matters are under consideration:

BL’s plant was commissioned and became operational on 1 April 2008 at a cost of Rs. 130
million.

At the time of commissioning its useful life and present value of decommissioning liability
was estimated at 20 years and Rs. 19 million respectively.

BL’s discount rate is 10%.

There has been no change in the above estimates till 30 September 2013 except for the
decommissioning liability whose present value as at 1 April 2013 was estimated at Rs. 25
million.

Required:
Compute the related amounts as they would appear in the statements of financial position
and comprehensive income of Bravo Limited for the year ended 30 September 2013 in
accordance with IFRS. (Ignore corresponding figures) (12)

QUESTION 18
Waste Management Limited (WML) had installed a plant in 2005 for generation of electricity
from garbage collected by the civic agencies. WML had signed an agreement with the
government for allotment of a plot of land, free of cost, for 10 years. However, WML has
agreed to restore the site, at the end of the agreement.

Other relevant information is as under:

(i) Initial cost of the plant was Rs. 80 million. It is estimated that the site restoration cost
would amount to Rs. 10 million.
(ii) It is the policy of the company to measure its plant and machinery using the
revaluation model.
(iii) When the plant commenced its operations i.e. on April 1, 2005 the prevailing market
based discount rate was 10%.
(iv) On March 31, 2007 the plant was revalued at Rs. 70 million including site restoration
cost.
(v) On March 31, 2009 prevailing market based discount rate had increased to 12%.
(vi) On March 31, 2011 estimate of site restoration cost was revised to Rs. 14 million.
(vii) Useful life of the plant is 10 years and WML follows straight line method of
depreciation.
(viii) Appropriate adjustments have been recorded in the prior years i.e. up to March 31,
2010.

Required:
Prepare accounting entries for the year ended March 31, 2011 based on the above
information, in accordance with International Financial Reporting Standards. (Ignore
taxation.) (16)

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 CAF 7 – IAS 37

QUESTION 19
Multan Petrochem Limited (MPL) operates in the oil extraction and refining business and is
preparing its draft financial statements for the year ended 31 December 2016. The following
information has been collected for the preparation of the provisions and contingencies notes.

(1) A new site was acquired on 1 January 2015 and is being used as the site for a new oil
refinery. Initial preparation work was undertaken at the site at the start of 2015 and the Page | 19
oil refinery was completed and ready for use on 31 December 2015. The new refinery
was expected to have a useful life of 25 years. MPL has a well-publicised policy that it
will reinstate any environmental damage caused by its activities. The present value of
the estimated cost of reinstating the environment is Rs. 1,300,000 for damage caused
during the initial preparation work. This amount is based on a discount rate of 8%.

(2) An explosion at one of MPL’s oil extraction plants on 1 July 2016 has led to a number of
personal injury claims being made by employees who were injured during the explosion.
Five claims have been made to date but if these claims are successful, it is likely that a
further three employees who were also injured will make a claim. MPL’s lawyers
estimate that it is probable that the claims will succeed and that the estimated average
cost of each payout will be Rs. 150,000. The lawyers have recommended that MPL
settles the claims out of court as quickly as possible at their estimated amount for all
eight employees injured to avoid any adverse publicity.

An additional two claims have been made by employees for the stress, rather than injury,
that the explosion has caused them. If these claims were to succeed the lawyers have
estimated that the likely payout would be around Rs. 10,000 per employee. However, the
lawyers have stated that they believe it to be unlikely that these employees will win such
a case.

MPL made an insurance claim to try to recover the personal injury costs that it is
probable that it will incur. The claim is now in its advanced stages and the insurance
company has agreed to meet the cost of the claims in full. The insurance company will
refund MPL once the claims have been settled.

(3) The future of MPL’s business operations is in doubt following the explosion at the oil
extraction plant. The national press criticised MPL for the way that it handled the
problem. To address this, on 1 October 2016 MPL paid Rs. 12,000 to a risk assessment
specialist who has recommended introducing a new disaster recovery plan at an
estimated cost of Rs. 500,000.

(4) MPL entered into an operating lease in the previous period for some office space.
However, the company’s plans changed and the office space was no longer required. At
1 January 2016 a correctly calculated provision had been made for the future
outstanding rentals of Rs. 80,000 for the remaining five years. This was based on a
discount rate of 8%. The rent paid during the period was Rs. 15,000. In addition, MPP
has signed a sub-lease to rent out the space for the first six months of next year for total
rental income of Rs. 6,000. No other tenants are expected to be found for the office
space.

Required
(a) Prepare the provisions and contingencies notes for inclusion in the financial statements
of MPP for the year ended 31 December 2016. (11)
(b) List the amounts that should be recognised in the statement of profit or loss for the year
ended 31 December 2016. (04)

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 CAF 7 – IAS 37

QUESTION 20
You have been asked to advise on the appropriate accounting treatment for the following
situations arising in the books of various companies. The year end in each case can be
taken as 31 December 2015 and you should assume that the amounts involved are material
in each case.
Page | 20 (a) At the year-end there was a debit balance in the books of a company for Rs.15,000,
representing an estimate of the amount receivable from an insurance company for an
accident claim. In February 2016, before the directors had agreed the final draft of
the published accounts, correspondence with lawyers indicated that Rs. 18,600 might
be payable on certain conditions.

(b) A company has an item of equipment which cost Rs.400,000 in 2012 and was
expected to last for ten years. At the beginning of the 2015 financial year the book
value was Rs. 280,000. It is now thought that the company will soon cease to make
the product for which the equipment was specifically purchased. Its recoverable
amount is only Rs.80,000 at 31 December 2015.

(c) On 30 November a company entered into a legal action defending a claim for
supplying faulty machinery. The company’s solicitors advise that there is a 20%
probability that the claim will succeed. The amount of the claim is Rs. 500,000.

(d) An item has been produced at a manufacturing cost of Rs.1,800 against a customer’s
order at an agreed price of Rs. 2,300. The item was in inventory at the year-end
awaiting delivery instructions. In January 2016 the customer was declared bankrupt
and the most reasonable course of action seems to be to make a modification to the
unit, costing approximately Rs. 300, which is expected to make it marketable with
other customers at a price of about Rs. 1,900.

(e) At 31 December a company has a total potential liability of Rs.1,000,400 for warranty
work on contracts. Past experience shows that 10% of these costs are likely to be
incurred, that 30% may be incurred but that the remaining 60% is highly unlikely to
be incurred.

Required
For each of the above situations outline the accounting treatment you would recommend and
give the reasoning of principles involved. The accounting treatment should refer to entries in
the books and/or the year-end financial statements as appropriate. (15)

QUESTION 21
J-Mart Limited, a chain of departmental stores has distributed its operations into four
Divisions i.e. Food, Furniture, Clothing and Household Appliances. The following information
has been extracted from the records:

(i) The company allows the dissatisfied customers to return the goods within 30 days. It
is estimated that 5% of the sales made in June 2015 will be refunded in July 2015.

(ii) On June 2, 2015, three employees were seriously injured as a result of a fire at the
company’s warehouse. They have lodged claims seeking damages of Rs. 2.0 million
from the company. The company’s lawyers have advised that it is probable that the
court may award compensation of Rs. 400,000.

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 CAF 7 – IAS 37

(iii) Under a new legislation, the company is required to fit smoke detectors at all the
stores by December 31, 2015. The company has not yet installed the smoke
detectors

(iv) On June 20, 2015, the board of directors decided to close down the Household
Appliances Division. However, the decision was made public after June 30, 2015.
Page | 21
(v) The company has a large warehouse in Lahore which was acquired under a three-
year rent agreement signed on April 1, 2014. The agreement is non- cancellable and
the company cannot sub-let the warehouse. However, due to operational difficulties,
the company shifted the warehouse to a new location.

(vi) A 15% cash dividend was declared on July 5, 2015.

Required
Describe how each of the above issue should be dealt with in the financial statements for the
year ended June 30, 2015. Support your point of view in the light of relevant International
Accounting Standards. (15)

QUESTION 22
Quality Garments Limited (QGL) is a manufacturer of readymade garments. During May
2014, a fire broke out in one of its units which resulted in deaths and severe injuries to a
number of workers.

At the time of finalization of QGL's financial statements for the year ended 30 June 2014, the
following issues pertaining to the fire are under consideration:

(i) Families of certain deceased workers have filed compensation claims amounting to
Rs. 60 million. A government agency has imposed a penalty of Rs. 35 million for
negligence on the part of the company. QGL's lawyers anticipate that the company
would have to pay Rs. 20 million and Rs. 10 million to settle the workers' claims and
the penalty respectively.

(ii) To maintain goodwill of the company, the Board of Directors is considering additional
payments to the families of the deceased workers amounting to Rs. 25 million.

(iii) Loss to fixed assets and inventories is estimated at Rs. 60 million. In this respect, a
fire insurance claim has been lodged. Due to certain policy clauses, QGL’s
consultant anticipates that the claim for Rs. 15 million may not be accepted. The
matter is under negotiation with the insurance company.

(iv) Due to closure of the unit for repair, QGL would not be able to meet sales orders of
Rs. 50 million. This will reduce QGL's profitability for the half year ending 31
December 2014 by Rs. 10 million.

Required:
Discuss how the above issues should be dealt with in the financial statements of QGL for the
year ended 30 June 2014. Support your answers in the context of relevant International
Financial Reporting Standards. (13)

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 CAF 7 – IAS 37

QUESTION 23
The following information pertains to Zamil Limited (ZL) for the year ended 31
December 2014:

(a) On 20 December 2014, ZL lodged a claim of Rs.10 million with one of its vendors for
supply of inferior quality goods. On 1 February 2015, the vendor agreed to adjust
Page | 22 Rs.6 million against future purchases of ZL. For the remaining claim amount, ZL took
up the matter with vendor’s parent company in UK and it is probable that 70% of the
remaining claim would be recovered. (04)

(b) In February 2015, it was revealed that ZL's cashier withdrew Rs. 10 million
fraudulently from Zl’s bank accounts. Of these, Rs. 7 million was withdrawn before 31
December 2014. ZL and its insurance company reached an agreement for settlement
of the claim at Rs. 8 million. (05)

(c) In October 2014, ZL decided to relocate its production unit from Sukkur to Karachi. In
this respect, a detailed plan was approved by the management and a formal
public announcement was made on 1 December 2014. ZL has planned to
complete the relocation by the end of June 2015. The related costs have been
estimated as under:
Rs. in
million
Redundancy cost 3.58
Relocation of staff to Karachi 0.45
Staff training 0.86
Salary of existing operation manager (responsible to supervise the
1.20
relocation)
6.09
(04)
(d) In December 2014, a citizen committee of the area met with the directors of the
company and lodged a complaint that ZL’s vehicles carrying chemicals are not fully
equipped with the safety equipment and resultantly creating serious threats to health
of the residents. The management held a meeting in this regard on 25 December
2014 and decided to install the safety equipment in its vehicles.

The estimated cost of installing the equipment is Rs.25 million. The company has
neither legal obligation nor any published policy regarding installation of such
safety equipment in its vehicles. (04)

Required:
Discuss how each of the above issues should be dealt with in ZL’s financial statements for
the year ended 31 December 2014. (Quantify effects where practicable)

QUESTION 24
A factory worker of Industrial Chemicals Limited (ICL) was seriously injured on 10 June 2015
during a production process. Subsequent developments in this matter are as follows:

(i) On 26 July 2015, the worker filed a claim for Rs. 25 million and alleged violation of
safety measures on the part of ICL. The lawyers of ICL anticipate that there is 60%
probability that the court would award Rs. 12 million and 40% likelihood that the
amount would be Rs. 8 million.

(ii) According to the terms of the insurance policy, ICL filed a claim of Rs. 18 million
which was principally accepted by the insurance company on 5 August 2015 to the

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 CAF 7 – IAS 37

extent of Rs. 14 million. ICL is negotiating with the insurance company and it is
probable that ICL would recover a further sum of Rs. 2 million.
(iii) On representation by the Labor Union, the management is considering to pay to the
affected worker an amount of Rs. 1.5 million, in addition to the compensation that
may be awarded by the court.
Required: Page | 23
Explain accounting treatment and the disclosure requirements in respect of the above
matters in ICL's financial statements for the year ended 30 June 2015. Support your answer
by referring to the relevant guidelines contained in International Financial Reporting
Standards. (12)

QUESTION 25
The following information pertains to Neptune Limited (NL) which is engaged in the
manufacturing of batteries and chemicals:
(a) In July 2015, NL was sued by a customer who claimed damages of Rs. 2 million on
account of supply of 2000 defective batteries in January 2015. The legal advisor at
that time anticipated that it is probable that the case would be decided in favor of the
customer.
In March 2016, an independent team submitted a report to the Court showing that
80% of the batteries were not faulty and there were minor defects in the remaining
batteries. As a result, the company's lawyer formed the view that it was highly
unlikely that the Court would award compensation to the customer.
On 5 July 2016, the Court decided the suit and ordered NL to replace all (20%) the
faulty batteries supplied to the customer. (05)
(b) In July 2014, NL entered into a two year contract with a supplier of raw material. With
effect from 1 November 2014, the supplier stopped the supply of raw material and
demanded price increase of 30%. Due to stoppage of supply, NL was unable to meet
its sales orders. NL filed a suit claiming damages of Rs. 40 million from the supplier
on 15 June 2015. On 30 June 2015, NL’s lawyer anticipated that NL would be
awarded damages up to 60% of its claim.

On 15 August 2016 the Court decided the case in favour of NL and awarded
damages of Rs.30 million to the company. (05)

(c) On 30 April 2015, NL’s Board of Directors decided to dispose of the chemical
division which was incurring heavy losses. The decision was made public on 10
December 2015. NL commenced negotiations with Venus Limited in March 2016. The
sale was finally executed on31July2016.
Costs incurred during the months of July and August 2016 in connection with the
closure of the division were as follows:
Rs. in million
Redundancy cost 10.5
Staff training for relocation to battery segment 3.5
Operating loss from 1 July 2016 till closure of business 2.0
(05)
Required:
Discuss giving reasons how each of the above issues should be dealt with in the financial
statements of NL for the years ended 30 June 2015 and 2016 in accordance with the
requirements of International Financial Reporting Standards. (Assume that NL’s financial
statements are authorized for issue three months after the year-end)

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 CAF 7 – IAS 37

QUESTION 26
Walnut Limited (WL) is engaged in the business of import and distribution of electronic
appliances.
The following events took place subsequent to the reporting period i.e. 31 December 2015:
(i) On 15 January 2016, one of WL’s competitors announced launching of an upgraded
Page | 24 version of DVD players. WL’s inventories include a large stock of existing version of
DVD players which are valued at Rs. 15 million. Because of the introduction of the
upgraded version, the net realizable value of the existing version in WL’s inventory at
31 December 2015 has reduced to Rs. 12.5 million.
(ii) On 20 December 2015, the board of directors decided to close down the division
which imports and sells mobile sets. This decision was made public on 29 December
2015. However, the business was actually closed on 29 February 2016. Net costs
incurred in connection with the closure of this division were as follows:
Rs. m
Redundancy costs 1.50
Staff training 0.15
Operating loss from 1 July 2015 to closure of division 0.80
Less: Profit on sale of remaining mobile sets (0.50)
1.95
(iii) On 16 January 2016, LED TV sets valuing Rs. 3 million were stolen from a
warehouse. These sets were included in WL’s inventory as at 31 December 2015.

(iv) WL owns 9,000 shares of a listed company whose price as on 31 December 2015
was Rs. 22 per share. During February 2016, the share price declined significantly
after the government announced a new legislation which would adversely affect the
company’s operations. No provision in this regard has been made in the draft
financial statements.

(v) On 31 January 2016, a customer announced voluntary liquidation. On 31 December

2015, this customer owed Rs. 1.5 million.

(vi) On 15 February 2016, WL announced final dividend for the year ended 31 December
2015 comprising 20% cash dividend and 10% bonus shares, for its ordinary
shareholders.

Required
Describe how each of the above transactions should be accounted for in the financial
statements of Walnut Limited for the year ended 31 December 2015. Support your answer in
the light of relevant International Financial Reporting Standards. (15)

QUESTION 27
Georgina Company is preparing its financial statements for the year ended 30 September
2015. The following matters are all outstanding at the year end.
(1) Georgina is facing litigation for damages from a customer for the supply of faulty goods
on 1 September 2015. The claim, which is for Rs. 500,000, was received on 15 October
2015. Georgina’s legal advisors consider that Georgina is liable and that it is likely that
this claim will succeed. On 25 October 2015 Georgina sent a counter-claim to its
suppliers for Rs. 400,000. Georgina’s legal advisors are unsure whether or not this claim
will succeed.

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 CAF 7 – IAS 37

(2) Georgina’s sales director, who was dismissed on 15 September, has lodged a claim for
Rs. 100,000 for unfair dismissal. Georgina’s legal advisors believe that there is no case
to answer and therefore think it is unlikely that this claim will succeed.

(3) Although Georgina has no legal obligation to do so, it has habitually operated a policy of
allowing customers to return goods within 28 days, even where those goods are not
faulty. Georgina estimates that such returns usually amount to 1% of sales. Sales in Page | 25
September 2015 were Rs. 400,000. By the end of October 2015, prior to the drafting of
the financial statements, goods sold in September for Rs. 3,500 had been returned.

(4) On 15 September 2015 Georgina announced in the press that it is to close one of its
divisions in January 2016. A detailed closure plan is in place and the costs of closure are
reliably estimated at Rs. 300,000, including Rs. 50,000 for staff relocation.

Required
State, with reasons, how the above should be treated in Georgina’s financial statements for
the year ended 30 September 2015. (12)

QUESTION 28
Akber Chemicals Limited is engaged in the business of manufacture and sale of different
type of chemicals. The following transactions have not yet been incorporated in the financial
statements for the year ended June 30, 2015:
(a) On June 15, 2015, one of its tankers carrying chemicals fell into a canal, thus
polluting the water. The company has never faced such a situation before. The
company has neither any legal obligation to clean the canal nor does it have any
published environmental policy. In a meeting held on July 26, 2015 the Board of
Directors decided to clean the canal, which is estimated to cost Rs. 5.5 million.

(b) During the second week of July 2015, a significant decline in the demand for
company’s products was observed which also led to a decrease in net realizable
value of finished goods. It was estimated that goods costing Rs. 25 million as at June
30, 2015 would only fetch Rs. 23 million.

(c) On June 21, 2015, a customer lodged a claim of Rs. 2 million with the company as a
consignment dispatched on June 1, 2015 was not according to the agreed
specifications. The company’s inspection team found that this defect arose because
of inferior quality of raw materials supplied by the vendor. On June 28, 2015, the
company lodged a claim for damages of Rs. 5.0 million, with its vendor, which
include reimbursement of the cost of raw materials. The company anticipates that it
will have to pay compensation to its customer and would be able to recover 50% of
the amount claimed from the vendor.

Required
Discuss how Akber Chemicals (Pvt.) Limited would deal with the above situations in its
financial statements for the year ended June 30, 2015. Explain your point of view with
reference to the guidance contained in the International Financial Reporting Standards. (12)

QUESTION 29
The following information pertains to Qallat Industries Limited (QIL) for its financial year
ended June 30, 2015:
(i) QIL sells all its products on one-year warranty which covers all types of defects.
Previous history indicates that 2% of the products contain major defects whereas
10% have minor defects. It is estimated that if major defects were detected in all the
products sold, repair cost of Rs. 150 million would result. If minor defects were

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detected in all products sold, repair cost of Rs. 70 million would result. Total sales for
the year are amounted to Rs. 830 million.

(ii) QIL has two large warehouses, A and B. These were acquired under non-cancellable
lease agreements. Details are as follows:
Warehouse A Warehouse B
Page | 26 Effective date of agreement July 1, 2010 January 1, 2013
Lease period 10 years 8 years
Rental amount per month Rs. 450,000 Rs. 300,000
On account of serious operating difficulties, QIL vacated both the warehouses on
January 1, 2015 and moved to a warehouse situated close to its factory. On the
same day QIL sub-let Warehouse A at Rs. 250,000 per month for the remaining
lease period. Warehouse B was sub-let on March 1, 2015 for Rs. 350,000 per month
for the remaining lease period.

(iii) On July 18, 2015, QIL was sued by an employee claiming damages for Rs. 6 million
on account of an injury caused to him due to alleged violation of safety regulations on
the part of the company, while he was working on the machine on June 15, 2015.
Before filing the suit, he contacted the management on June 29, 2015 and asked for
compensation of Rs. 4 million which was turned down by the management. The
lawyer of the company anticipates that the court may award compensation ranging
between Rs. 1.5 million to Rs. 3 million. However, in his view the most probable
amount is Rs. 2 million.

(iv) On November 1, 2014 a new law was introduced requiring all factories to install
specialised safety equipment within four months. The Equipment costing Rs. 5.0
million was ordered on December 15, 2014 against 100% advance payment but the
supplier delayed installation to July 31, 2015. On August 5, 2015 the company
received a notice from the authorities levying a penalty of Rs. 0.4 million i.e. Rs. 0.1
million for each month during which the violation continued. QIL has lodged a claim
for recovery of the penalty from the supplier of the equipment.

Required
Describe how each of the above issues should be dealt with in the financial statements for
the year ended June 30, 2015. Support your answer in the light of relevant International
Accounting Standards and quantify the effect where possible. (16)

QUESTION 30
The following information pertains to Skyline Limited (SL) for the financial year ended
December 31, 2015:
(i) A customer who owed Rs. 1 million was declared bankrupt after his warehouse was
destroyed by fire on February 10, 2016. It is expected that the customer would be
able to recover 50% of the loss from the insurance company.

(ii) An employee of SL forged the signatures of directors and made cash withdrawals of
Rs. 7.5 million from the bank. Of these, Rs. 1.5 million were withdrawn before
December 31, 2015. Investigations revealed that an employee of the bank was also
involved and therefore, under a settlement arrangement, the bank paid 60% of the
amount to SL on January 27, 2016.

(iii) SL has filed a claim against one of its vendors for supplying defective goods. SL’s
legal consultant is confident that damages of Rs. 1 million would be paid to SL. The
supplier has already reimbursed the actual cost of the defective goods.

Latest update: March 2020

 CAF 7 – IAS 37

(iv) A suit for infringement of patents, seeking damages of Rs. 2 million, was filed by a
third party. SL’s legal consultant is of the opinion that an unfavourable outcome is
most likely. On the basis of past experience he has advised that there is 60%
probability that the amount of damages would be Rs. 1 million and 40% likelihood
that the amount would be Rs. 1.5 million.

Required Page | 27
Advise SL about the amount of provision that should be incorporated and the disclosures
that are required to be made in the financial statements for the year ended December 31,
2015. (12)

QUESTION 31
Naba Power Limited (NPL) is preparing its financial statements for the year ended 30 June
2017. Following issues are under consideration.
(a) NPL entered into a contract on 1 August 2016 to supply customised batteries to a
new customer. As per the terms of the agreement, NPL is required to deliver 50,000
batteries at the end of each month from December 2016 to September 2017 at a
consideration of Rs. 15 million per month. Penalty for each late delivery or
cancellation of the contract would be Rs. 5 million and Rs. 20 million respectively.

On 1 August 2016 NPL had estimated that cost of production would be Rs. 10 million
per month. However, cost of production increased subsequently. Despite the
increase in the cost of production, NPL made timely deliveries till May 2017 at a total
cost of Rs. 99 million. Supply for June 2017 was made on 15 July 2017 at a total cost
of Rs. 18 million of which Rs. 14 million had been incurred till 30 June 2017. It is
estimated that Rs. 55 million would need to be spent to make the last 3 deliveries
within time. (06)
(b) On 15 May 2017 an explosion occurred at one of NPL’s factories. Several claims
were filed by affected employees against NPL. The details are as under:
(i) Seven injured employees made claims before 30 June 2017 and further three
injured employees lodged claims in July 2017. According to NPL’s legal
advisor, the probability that NPL would be determined to be negligent is 80%.
If NPL is found negligent, the estimated average cost of each payout will be
Rs. 1 million.
(ii) Additional four employees made claims before 30 June 2017, seeking
compensation for the stress, rather than any injury, caused to them. If these
claims succeed, the legal advisor is of the view that the estimated average
cost of each payout will be Rs. 0.7 million. However, according to the legal
advisor, the chance that these employees will succeed is 30%.
(iii) 80% of all such payouts are recoverable according to the terms of the
insurance policy. (05)
(c) On 1 November 2016 a new law was introduced requiring all factories to install
specialized safety equipment within five months. The equipment costing Rs. 15
million was ordered in February 2017 to be installed by 30 April 2017. However the
supplier delayed installation till 31 July 2017. On 5 August 2017 the company
received a notice from the authorities levying a penalty of Rs. 1.6 million i.e. Rs. 0.4
million for each month during which the violation continued. It is probable that this
penalty will be recovered from the supplier. (04)
Required:
Discuss how each of the above issues should be dealt with in NPL’s financial statements for
the year ended 30 June 2017. (Quantify effects where practicable)

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QUESTION 32
For the purpose of this question, assume that the date today is 15 February 2018.

Melon Limited (ML) is in the process of finalizing its financial statements for the year ended
31 December 2017. Following matters are under consideration:
(i) ML undertook a sales campaign in December 2017 whereby customers can avail
Page | 28 20% discount on the purchase of its new product by presenting a coupon, which
formed part of newspaper advertisements. The offer is valid from 1 January 2018 to
28 February 2018. So far discounts of Rs. 4.5 million have been availed and the
management estimates that a further discount of Rs. 3 million will be given before the
end of the scheme.

(ii) On 15 December 2017, a machine was disposed of for Rs. 3.5 million to Raspberry
Limited (RL) for cash. However, as per agreement ML was also entitled to additional
amount of Rs. 1.5 million which is dependent upon passing certain production tests
after installation at RL’s premises. On 25 January 2018 RL confirmed that the
required production testing had successfully been completed.

(iii) On 10 December 2017, a worker filed a claim of Rs. 2.5 million and alleged violation
of safety measures on the part of ML. As of 31 December 2017 the legal advisor of
ML advised that there was only a remote possibility that the Court would award any
compensation to the worker.
The case is still pending, however ML’s legal advisor now believes that there is a
40% chance that the Court would award compensation of Rs. 2 million to the worker.

(iv) In November 2017, as part of restructuring plan an option of early retirement in

exchange for a one-off payment of Rs. 1 million was offered to each employee aged
above 50 years. According to restructuring plan, management expects that 25
employees would accept the offer. The option can be exercised till 31 March 2018.
10 employees have already opted for the scheme till 31 December 2017. A further 6
employees have opted for the scheme after year-end.
Costs related to the restructuring except one-off payments to employees have
already been provided by ML in its financial statements.

Required:
Discuss how each of the above matters should be dealt with in ML’s financial statements for
the year ended 31 December 2017. (12)

QUESTION 33
Rowsley is a diverse group with many subsidiaries. The group is proud of its reputation as a
‘caring’ organisation and has adopted various ethical policies towards its employees and the
wider community in which it operates. As part of its Annual Report, the group publishes
details of its environmental policies, which include setting performance targets for activities
such as recycling, controlling emissions of noxious substances and limiting use of non-
renewable resources.

The finance director is reviewing the accounting treatment of various items prior to finalising
the accounts for the year ended 31 March 20X4. All items are material in the context of the
accounts as a whole. The accounts are due to be approved by the directors on 30 June
20X4.

Closure of factory
On 15 February 20X4, the board of Rowsley decided to close down a large factory in Derby
town.

Latest update: March 2020

 CAF 7 – IAS 37

The board is trying to draw up a plan to manage the effects of the reorganisation, and it is
envisaged that production will be transferred to other factories. The factory will be closed on
31 August 20X4, but at 31 March 20X4 this decision had not yet been announced to the
employees or to any other interested parties. Costs of the reorganisation have been
estimated at Rs. 45 million (04)
Page | 29
Relocation of subsidiary
During December 20X3, one of the subsidiary companies moved from Buckington to
Sundertown in order to take advantage of government development grants. Its main
premises in Buckington are held under an operating lease, which runs until 31 March 20X9.
Annual rentals under the lease are Rs. 10 million. The company is unable to cancel the
lease, but it has let some of the premises to a charitable organisation at a nominal rent. The
company is attempting to rent the remainder of the premises at a commercial rent, but the
directors have been advised that the chances of achieving this are less than 50%.
(04)
Legal claim
During the year to 31 March 20X4, a customer started legal proceedings against the group,
claiming that one of the food products that it manufactures had caused several members of
his family to become seriously ill. The group’s lawyers have advised that this action will
probably not succeed. (03)

Environmental impact of overseas subsidiary

The group has an overseas subsidiary that is involved in mining precious metals. These
activities cause significant damage to the environment, including deforestation. The
company expects to abandon the mine in eight years’ time. The mine is situated in a country
where there is no environmental legislation obliging companies to rectify environmental
damage and it is very unlikely that any such legislation will be enacted within the next eight
years. It has been estimated that the cost of cleaning the site and re-planting the trees will
be Rs. 25 million if the re-planting was successful at the first attempt, but it will probably be
necessary to make a further attempt, which will increase the cost by a further Rs. 5 million.
(04)
Required
Explain how each of the items above should be treated in the consolidated financial
statements for the year ended 31 March 20X4

QUESTION 34
Oval Limited (OL) deals in medicines and surgical instruments. OL is in the process of
finalizing its financial statements for the year ended 31 December 2018. Following matters
are under consideration:
(i) OL sells instruments A-1 and B-1 with 1-year warranty. These units are purchased
from a manufacturer Star Limited (SL). The details of warranty are as under:
A-1: SL provides warranty services to the customers and recovers 50% of the cost
from OL. However, in case of SL’s default, the warranty services would have
to be provided by OL.
B-1: OL provides warranty services to the customers and recovers the entire cost
from SL.
On 31 December 2018, it is estimated that total cost of Rs. 4 million and Rs. 7 million
would be incurred in next year for providing warranty services for A-1 and B-1
respectively sold in 2018.

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(ii) In October 2018, OL was sued by a customer for Rs. 18 million on account of supply
of substandard surgical instruments.
By end of the year, OL communicated to the customer via email to pay Rs. 5 million.
In respect of the remaining amount of the claim, OL’s lawyers anticipate that there is
70% probability that the court would award Rs. 6 million and 30% probability that the
Page | 30 amount would be Rs. 4 million.
OL lodged a claim with the supplier in December 2018. The supplier principally
accepted the claim to the extent of Rs. 9 million. However, OL is still negotiating with
the supplier and it is probable that OL would recover a further sum of Rs. 3 million.

(iii) OL has imported 7,000 units of a medicine at a cost of Rs. 70 million. However, in
November 2018, a study was published in a medical journal which reveals that
results of an alternate medicine are much better. At year end, 5000 units were in
stock. On 25 January 2019, 4000 units were sold at Rs. 8,000 per unit. OL also paid
10% commission.

Required:
Discuss how the above issues should be dealt with in the financial statements of OL for the
year ended 31 December 2018. Support your answers in the context of relevant IFRSs.
(12)

QUESTION 35
Turquoise Limited (TL) is in the process of finalizing its financial statements for the year
ended 30 June 2019. Following matters are under consideration:

(i) On 10 July 2019, the owner of the adjacent building filed a case against TL claiming
Rs. 50 million. The claim is made in respect of severe damage to his building during
a fire incident in TL’s head office in June 2019. He is of the view that TL was
negligent in maintaining fire safety systems in its head office. According to TL’s
lawyers, there is 70% probability that TL would be found negligent and would need to
pay 40% of the amount claimed. (04)

(ii) In May 2019, TL’s board of directors decided to relocate its regional office from
Multan to Lahore. In this respect, a detailed plan was approved by the management
and a formal public announcement was made in June. TL has planned to complete
the relocation by December 2019. The related costs have been estimated as under:
Rs. in million
Redundancy payments 20
Costs of moving office equipment to Lahore 3
Compensation to employees agreeing to relocate 10
Salary of existing operation manager (responsible to supervise
2
the relocation)
(04)

(iii) TL had 6,000 unsold units of product A as on 30 June 2019 acquired at Rs. 500 per
unit. In June 2019, the selling price of product A has fallen to Rs. 350 per unit.

TL acquires product A under the contract in which TL has to buy 10,000 units of
product A per month for Rs. 500 per unit. The contract is valid till 31 August 2019 and
if TL decides to cancel the contract, then it must pay a cancellation penalty of Rs. 4
million. TL is of view that the market may not improve in near future. (04)

Latest update: March 2020

 CAF 7 – IAS 37

(iv) TL sells product B with a warranty of 12 months, though the manufacturer i.e.
Sulphur Limited (SL) provides a warranty of 8 months only. Warranty services are
provided by SL. However, TL is responsible if SL fails to honour its obligation for this
warranty. If warranty claim arises within 8 months, SL does not charge any cost.

However, SL charges Rs. 500, Rs. 1,000 and Rs. 2,500 for a minor, moderate and
major defect respectively in each unit if the defect arises in the extended warranty Page | 31
period of 4 months offered by TL. The probability that a warranty claim in respect of a
unit sold may arise, is as under:

Nature of defect First 8 months Last 4 months

Minor 12% 6%
Moderate 7% 10%
Major 4% 5%

During the year ended 30 June 2019, a total of 12,000 units of product B has been
sold by TL and warranty cost of Rs. 1.2 million has been paid to SL in respect of
these units. (05)

Required:
Discuss how the above issues should be dealt with in the financial statements of TL for the
year ended 30 June 2019. Support your answers in the context of relevant IFRSs.

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 CAF 7 – IAS 37

Page | 32

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 01
The obligating event is the sale of the product with a warranty, which
Obligation?
gives rise to a legal obligation.
Outflow? Probable for the warranties as a whole
1. Estimate? Assume that reliable estimate can be made
Page | 33
A provision is recognised for the best estimate of the costs of making
Conclusion: good under the warranty products sold before the end of the reporting
period
The obligating event is the contamination of the land, which gives rise
to a constructive obligation because the conduct of the entity has
Obligation?
created a valid expectation on the part of those affected by it that the
2. entity will clean up contamination.
Outflow? Probable.
Estimate? Assume that reliable estimate can be made
Conclusion: A provision is recognised for the best estimate of the costs of clean-up
The construction of the oil rig creates a legal obligation under the
terms of the licence to remove the rig and restore the seabed and is
Obligation? thus an obligating event. At the end of the reporting period, however,
there is no obligation to rectify the damage that will be caused by
extraction of the oil.
Outflow? Probable.
3. Estimate? Assume that reliable estimate can be made
A provision is recognised for the best estimate of ninety per cent of
the eventual costs that relate to the removal of the oil rig and
restoration of damage caused by building it. These costs are included
Conclusion:
as part of the cost of the oil rig. The 10 per cent of costs that arise
through the extraction of oil are recognised as a liability when the oil is
extracted.
The obligating event is the sale of the product, which gives rise to a
constructive obligation because the conduct of the store has created a
Obligation?
valid expectation on the part of its customers that the store will refund
4. purchases.
Outflow? Probable, a proportion of goods are returned for refund
Estimate? Assume that reliable estimate can be made
Conclusion: A provision is recognised for the best estimate of the costs of refunds
There is no obligation because there is no obligating event either for
Obligation?
the costs of fitting smoke filters or for fines under the legislation.
5. Outflow? Not applicable
Estimate? Assume that reliable estimate can be made
Conclusion: No provision is recognised for the cost of fitting the smoke filters
There is still no obligation for the costs of fitting smoke filters because
no obligating event has occurred (the fitting of the filters). However, an
Obligation? obligation might arise to pay fines or penalties under the legislation
because the obligating event has occurred (the non-compliant
operation of the factory).
Assessment of probability of incurring fines and penalties by non-
6.
Outflow? compliant operation depends on the details of the legislation and the
stringency of the enforcement regime.
Estimate? Assume that reliable estimate can be made
No provision is recognised for the costs of fitting smoke filters.
Conclusion: However, a provision is recognised for the best estimate of any fines
and penalties that are more likely than not to be imposed

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 CAF 7 – IAS 37

There is no obligation because no obligating event (retraining) has

Obligation?
taken place.
7. Outflow? Not applicable.
Estimate? Assume that reliable estimate can be made
Conclusion: No provision is recognised
On the basis of the evidence available when the financial statements
Page | 34 Obligation?
were approved, there is no obligation as a result of past events.
Outflow? Not applicable.
Estimate? Assume that reliable estimate can be made
8.
No provision is recognised.
Conclusion:
The matter is disclosed as a contingent liability unless the probability
of any outflow is regarded as remote
Obligation? On the basis of the evidence available, there is a present obligation.
Outflow? Probable
9. Estimate? Assume that reliable estimate can be made
A provision is recognised for the best estimate of the amount to settle
Conclusion:
the obligation
Obligation? There is no present obligation.
Outflow? Not applicable.
Estimate? Assume that reliable estimate can be made
No provision is recognised

The cost of replacing the lining is not recognised because, at the end
of the reporting period, no obligation to replace the lining exists
10.
independently of the company’s future actions—even the intention to
Conclusion: incur the expenditure depends on the company deciding to continue
operating the furnace or to replace the lining. Instead of a provision
being recognised, the depreciation of the lining takes account of its
consumption, ie it is depreciated over five years. The re-lining costs
then incurred are capitalised with the consumption of each new lining
shown by depreciation over the subsequent five years.
Obligation? There is no present obligation.
Outflow? Not applicable.
Estimate? Assume that reliable estimate can be made
No provision is recognised

The costs of overhauling aircraft are not recognised as a provision for

the same reasons as the cost of replacing the lining is not recognised
as a provision in above example. Even a legal requirement to
11.
overhaul does not make the costs of overhaul a liability, because no
Conclusion: obligation exists to overhaul the aircraft independently of the entity’s
future actions—the entity could avoid the future expenditure by its
future actions, for example by selling the aircraft. Instead of a
provision being recognised, the depreciation of the aircraft takes
account of the future incidence of maintenance costs, ie an amount
equivalent to the expected maintenance costs is depreciated over
three years.

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 02
The best estimate in this case is expected value of the warranty expenditure. The expected
value of the cost of repairs is:
Rs.
Rs. Nil x 75% Nil
Rs. 850,000 x 20% 170,000
Rs. 4,500,000 x 5% 225,000 Page | 35
Expected value 395,000

ANSWER 03
Due to recent technological development, the entity shall consider the amount of provision to
be Rs. 3 million so as to reflect the impact of future events. Further, as the effect of time
value of money seems to be material, this amount shall be discounted.

Rs. 3,000,000 x (1+10%)-10 = Rs. 1,156,630

The journal entry:

Date Particulars Dr. Rs Cr. Rs
01.01.11 Plant Rs. 20,000,000 + 1,156,630 21,156,630
Cash / Bank 20,000,000
Provision for restoration 1,156,630
(Initial recognition of plant and related provision)

ANSWER 04

The obligating event is the contamination of the land because of the virtual
Obligation? certainty of legislation requiring cleaning up.

Outflow? Probable

Estimate? Rs. 4,000,000

Conclusion: A provision is recognised for the best estimate of the costs of the clean-up

ANSWER 05
Gains from the expected disposal of assets are not taken into account while measuring a
provision. Therefore, a provision at present value of Rs. 1 million shall be recognised.

ANSWER 06
The journal entry:
Date Particulars Dr. Rs Cr. Rs
xx.xx.xx Recoverable from sub-contractor 2,000,000
Compensation expense (P&L) 1,000,000
Provision for damages 3,000,000

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 CAF 7 – IAS 37

ANSWER 07
The journal entries are:
Date Particulars Dr. Rs Cr. Rs
xx.xx.xx Provision for damages claim I 5,000,000
P&L 5,000,000
(reversal in provision due to change in best estimate)
Page | 36
xx.xx.xx Provision for claim II 4,000,000
P&L 4,000,000
(reversal of provision as it is no longer probable outflow
of economic benefits)

xx.xx.xx P&L (Damages expense) 4,000,000

Cash / Bank 4,000,000
(this shall be separately recognised and cannot be
settled against provision recognised for another use)

ANSWER 08

The obligating event is the signing of the lease contract, which gives rise to
Obligation? a legal obligation.

When the lease becomes onerous, an outflow of resources embodying

Outflow?
economic benefits is probable.

Estimate? Rs. 100,000 x 3.1699 = Rs. 316,990

Conclusion: A provision is recognised for the best estimate of the unavoidable lease

ANSWER 09
The journal entries are:
Date Particulars Dr. Rs Cr. Rs
31.12.10 Loss on onerous contract (P&L) 400
Provision for expected loss (onerous contract) 400
(Supply contract, increased price on short quantities Rs
12-10 = Rs. 2 x (1,000 – 800 units) = Rs. 400)

Date Particulars Dr. Rs Cr. Rs

31.12.10 Loss on onerous contract (P&L) 1,500
Provision for expected loss (onerous contract) 1,500
(Firm purchase contract Rs. 10 – 7 = Rs. 3 x 500 units =
Rs. 1,500)

ANSWER 10
Present obligation as a result of a past obligating event– There has been no obligating
event and so there is no obligation.
Conclusion – No provision is recognised

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 11
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.
Page | 37
An outflow of resources embodying economic benefits in settlement – Probable

Conclusion – A provision is recognised at 31 December 2010 for the best estimate of the
costs of closing the division.

ANSWER 12
Include
(a) Shifting allowance to employees Rs. 500,000 No
(b) Consultant fee Rs. 700,000 Yes
(c) New computer and distribution network systems Rs. 1,500,000 No
(d) Staff training Rs. 50,000 No
(e) Advertisement of new and improved operations Rs. 120,000 No
(f) Implementation expenses specifically incurred for restructuring Rs. Yes
450,000

ANSWER 13
Debit Credit
Date Description
Rs. in million
1.1.15 Plant (W1) 1,743.49
Sales tax refundable 255.00
Bank 1,755.00
Provision for decommissioning (W2) 243.49
To record purchase of plant and provision for
decommissioning

31.12.15 Finance cost (W2) 26.78

Provision for decommissioning 26.78
To record finance cost on unwinding of discount

31.12.15 Depreciation expense (1743.49/2) 871.75

Accumulated depreciation 871.75
To record Depreciation for the year

31.12.16 Finance cost (W2) 29.73

Provision for decommissioning 29.73
To record finance cost on unwinding of discount

31.12.16 Depreciation expense (1743.49/2) 871.75

Accumulated depreciation 871.75
To record Depreciation for the year

31.12.16 Provision for decommissioning 300.00

Bank 300.00
To record payment of decommissioning liability

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 CAF 7 – IAS 37

31.12.16 Accumulated depreciation 1,743.49

Plant 1,743.49
To record reversal of plant & accumulated
depreciation thereon upon end of its life.
W1 Computation of cost of plant Rs. in million
Page | 38 Amount inclusive of sales tax 1,755.00
Less: Sales tax (1,755 x 17/117) (255.00)
Amount net of sales tax 1,500.00
Add: Provision for decommission cost – (W2) 243.49
1,743.49
W2 Provision for decommissioning cost Rs. in millions
Amount of Discount Liability Finance
Date
liability factor @ 11% balance charges
1.1.15 300 0.816 243.49 -
31.12.15 300 0.9009 270.27 26.78
31.12.16 300 1.000 300.00 29.73

ANSWER 14
IAS 37 only permits a provision to be made if three conditions are met:
(i) The company has a present obligation, either legally or constructively, as a result of a
past event;
(ii) Probable outflow of resources is required to settle the obligation; and
(iii) A reliable estimate is available.
Although there is no legal requirement to restore the site, the company has established a
constructive obligation by setting a valid expectation in the market, due to its published
policies and past practice, from which it cannot realistically withdraw.
It therefore appears probable that Badar will have to pay money to improve the site and so a
provision should be created for the expected amount. As the expected payment of
Rs.100,000 will not be settled for three years, the provision should be discounted and
entered at its net present value of Rs.75,131 Rs.100,000/(1.1)3). Over the three years, the
discounting should be unwound and charged to profit or loss as finance costs, resulting in a
provision of Rs.100,000 by the end of the third year.
The cost of the construction work has been correctly capitalized. The cost of the future
decommissioning work should be added to this asset so that the total costs of the site can be
matched to the revenue from the copper over the period of mining.
This will result in an asset of Rs.575,131 which should be depreciated over the three year
life in line with anticipated revenues.

ANSWER 15
PPE Prov.
Rs. m Rs. m
Initial cost 6,570
Initial provision 780 x (1.08)-20 167 167
6,737
Dep. (6,737 – 320) / 20 years (321)
Interest 167 x 8% 13
180
Increase in provision β 157 157
June 30, 2016  Provision 1,021 x (1.06)-19 6,573 337

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 16
Net Total Total
profit assets liabilities
-------Rs. in million------
As per question 125 1,420 925
Page | 39
Revaluation of plant (see below) 8.35
Increase in provision (see below) 7.94
Revised amounts 125 1,428.35 932.94

PPE Prov. PL RS/OCI

Rs. m Rs. m Rs. m Rs. m
As given & 30 x (1.08)-3 135.4 23.81 3.15
Increase in provision 7.94 4.79 (3.15)
Revaluation effect 8.35 (4.79) 3.56
June 30, 2016  40 x (1.08)-3 143.75* 31.75 Nil 3.56
*112 + 31.75 = 143.75

ANSWER 17
Bravo Limited
Relevant financial statement amounts
For the year ended 30 September 2013
PPE Prov. PL
Rs. m Rs. m Rs. m
1 April 2008 [130 + 19] 149 19
Depreciation 149 / 20 x 4.5 years (33.53)
Interest 19 x 1.104.5 -19 10.18
1 Oct 2012 115.47 29.18
Depreciation 149 / 20 x 0.5 years (3.73) 3.73
Interest (19 x 1.105) - (19 x 1.104.5) 1.42 1.42
30.6
Increase in provision (5.6) (5.6)
106.15 25
Depreciation 106.15 / 15 x 0.5 years 3.54 3.54
Interest 25 x 1.100.5 – 25 1.22 1.22
102.61 26.22 9.91

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 CAF 7 – IAS 37

ANSWER 18
Movement PPE Prov. PL RS/OCI
Rs. m Rs. m Rs. m Rs. m
1 April 2005 [80+3.86 i.e. 10 x 1.10-10] 83.86 3.86
2006 Depreciation (10 years) (8.39)
Page | 40
2006 Interest 3.86 x 10% 0.39
2007 Depreciation (10 years) (8.39)
2007 Interest (3.86+0.39) x 10% 0.43
67.08
Revaluation effect 2.92 2.92
31 March 2007 70 4.68
2008 Dep. & Incremental (8 years) (8.75) (0.365)
2008 Interest 4.68 x 10% 0.47
2009 Dep. & Incremental (8 years) (8.75) (0.365)
2009 Interest (4.68+0.47) x 10% 0.51
5.66 2.19
Change in provision 10% to 12% (0.59) 0.59
31 March 2009  10 x 1.12-6 52.5 5.07 2.78
2010 Dep. & Incremental (6 years) (8.75) (0.46)
2010 Interest 5.07 x 12% 0.61
2011 Dep. & Incremental (6 years) (8.75) (0.46)
2011 Interest (5.07+0.61) x 12% 0.68
6.36 1.86
Change in provision 10 to 14 2.54 0.68 (1.86)
31 March 2011  14 x 1.12-4 35 8.90 Nil
Journal entries
Date Particulars Ref. Dr. Cr.
Rs. in million
31-03-11 PL Account (Depreciation exp) 8.75
Accumulated depreciation 8.75
PL Account (Unwinding of discount) 0.68
Site restoration liability (Unwinding) 0.68
Revaluation surplus (Incremental depreciation) 0.46
Retained earnings 0.46
PL account 0.68
Revaluation surplus 1.86
Site restoration liability 2.54

ANSWER 19
Part (a)
Provisions and contingencies
Environmental Legal Onerous Total
damage claims lease
At 1 Jan 2016 1,300,000 – 80,000 1,380,000
Unwinding of the discount (8%) 104,000 6,400 110,400
Utilised in the year – – (15,000) (15,000)
Charge/(credit) to PL – 1,200,000 (6,000) 1,194,000
At 31 Dec 2016 (W) 1,404,000 1,200,000 65,400 2,669,400

Latest update: March 2020

 CAF 7 – IAS 37

Environmental damage
The provision in respect of the environmental damage relates to restoration of land following
the initial ground work undertaken to set up a new oil refinery. The company has an
advertised policy that it will restore all environmental damage caused by its business
operations. The provision is based on the estimated cost of reinstating the environmental
damage caused and is not likely to be paid until 2040.
Page | 41
Legal claims
During the year an explosion at one of the company’s oil extraction plants caused a number
of employees to suffer injury. This provision is to cover personal injury claims made by the
individuals concerned. The provision is based on lawyers’ best estimate of the likely amount
at which the claims can reasonably be settled. It is hoped that the claims will be settled in the
next financial year. It is expected that the full amount of these claims will be reimbursed by
an insurance company following their payment.

Onerous lease
The company has an ongoing lease obligation in respect of office space that is not being
utilised by the company. The outstanding lease liability at the year-end was Rs. 65,000 and
the lease has another four years to run. MPP has found a tenant for the office space on a six
month short lease and this will reduce the outstanding obligation by Rs. 6,000 in 2017.

Contingent liability
Following the explosion at the oil extraction plant a number of employees have made claims
against the company for undue stress. Based on lawyers’ advice the company do not believe
that it is probable that a court case against the company will be brought. If such a case was
to be heard the estimated payout in total is Rs. 20,000.

Workings
Personal injury claims: 8 × 150,000 = 1,200,000
Onerous lease: (80,000 – 15,000) – 6,000 = 59,000 + 6,400 interest = Rs. 65,400

Part (b)
Summary of amounts included in income statement for year ended 31 December 2016
Operating costs: Rs.
Movement in provision (total expense calculated above) 1,194,000
Consultancy fees 12,000
Depreciation on oil refinery environmental damage (1,300,000 ÷ 25yrs) 52,000

Borrowing costs
Unwinding of the discount 110,400
Other operating income:
Insurance reimbursement (150,000 x 8 claims) 1,200,000

ANSWER 20
Part (a)
IAS 37 states that contingent gains should not be recognized as income in the financial
statements. The company has a debit balance already in its books which indicates that it
must be reasonably certain that at least part of the claim will be paid. This element of the
claim then is probably not a contingency at all. The remaining part (the difference between
the Rs.15,000 and the Rs.18,600) is, and should be disclosed and not accrued.

Part (b)
IAS 16 requires that the carrying amount of property, plant and equipment should be
reviewed periodically in order to assess whether the recoverable amount has fallen below

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 CAF 7 – IAS 37

the carrying amount. Where it has, the property, plant and equipment should be written down
to the recoverable amount through the statement of profit or loss as an expense. In this case
this would result in the recognition of a depreciation expense of Rs. 40,000 (i.e. Rs. 400,000/
10 years) and Rs. 160,000 impairment loss [(280,000 – 40,000) – Rs. 80,000].

Part (c)
Page | 42 IAS 37 states that contingent liabilities should not be recognized. The question in this case is
whether or there is an obligating event within the context of IAS 37. On balance it seems
inappropriate to recognize a provision in respect of this amount but the possible liability
should be disclosed as a contingent liability.
(i) the nature of the contingency
(ii) the uncertainties surrounding the ultimate outcome
(iii) the likely effect, i.e. Rs.500,000 loss less likely tax relief.

Part (d)
IAS 2 requires that inventories be stated at the lower on cost and net realizable value. Net
realizable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale. In this
case, cost is Rs.1,800 and net realizable value is Rs.1,600 [i.e. Rs. 1,900 – 300]. So,
inventory should be written down by Rs.200.

Part (e)
The company should set up a provision for Rs.100,040, i.e. should accrue for the 10%
probable liability. It should disclose the possible liability under contingent liabilities. The
disclosure is as noted in (c) except that the financial effect is Rs.300,120 (30% of
Rs.1,000,400). The balance should be ignored as it is a remote contingent liability.

ANSWER 21
Part (i)
The conditions attached to the sale give rise to a constructive obligation on the reporting
date. A provision for the sales return should be recognized for 5% of June 2015 sales. The
related cost should also be reversed.
Part (ii)
Since the law suit was already in progress at year-end and the amount of compensation can
also be estimated, it is an adjusting event. A provision of Rs. 400,000 should be made.
Part (iii)
There is no obligating event at the year-end either for the costs of fitting the smoke detectors
or for fines under the legislation. No provision should be recognized in this regard.
Part (iv)
The obligating event is the communication of 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. Since no communication has yet been made, no
provision is required in this regard.
Part (v)
The obligating event is the signing of the lease contract, which gives rise to a legal
obligation. A provision is required for the unavoidable rent payments.
Part (vi)
Since the declaration was announced after year-end, there is no past event and no
obligation at year-end and is therefore non-adjusting event. Details of the dividend
declaration must, however, be disclosed.

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 22
Quality Garments Limited
Accounting treatment for the issues pertaining to the fire
IAS 37 prescribes the following accounting and disclosure requirements for provisions,
contingent liabilities and contingent assets.
Provisions: Page | 43
A provision shall be recognized when all of the following conditions are met:
 There is a present obligation (legal or constructive) as a result of past event.
 It is probable that outflow of resources will be required to settle the obligation.
 A reliable estimate can be made of the amount of the obligations.
Reimbursements:
Where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party:
 The reimbursement shall be recognised where it is virtually certain that
reimbursement will be received.
 The amount recognized in respect of the reimbursement shall not exceed the amount
of provision.
 The reimbursement receivable shall be treated as a separate asset.
Disclosure for contingent liabilities and assets:
Where a disclosure of a contingent liability or a contingent asset is appropriate, for each
class of contingent liability/asset, the following disclosures are required:
 A brief description of the nature of the contingent liability/asset.
 Where practicable:
 an estimate of its financial effect,
 and an indication of uncertainties
 The possibility of any reimbursement.
In view of the above, issues as given would be dealt in QGL’s financial statements as under:

Part (i) Liability for workers’ compensation and penalty

All the conditions as mentioned for provisions are met to the extent of Rs. 20 million for the
claims of families of workers and Rs. 10 million for the penalty levied by a government
agency. Therefore, a provision of Rs. 30 million (20+10) would be made.

For the remaining amount of Rs. 65 million (60+35-30), it is not probable that an outflow of
economic benefits will be required. Therefore, a contingent liability would be disclosed giving
information as per the above requirements.

Part (ii) Additional compensation for the families of the deceased workers:
The obligation for additional compensation to the families of the deceased workers is neither
legal nor constructive as the matter is still under consideration and no formal announcement
was made that may create a valid expectation. Therefore, no provision or disclosure is
required in this respect.

Part (iii) Insurance claim

As the insurance claim to the extent of Rs. 45 million (60-15) is virtually certain to be
received; an insurance claim would be recognized for this amount.

Where an inflow for the remaining amount of Rs. 15 million is probable, a contingent asset
would be disclosed giving information as per the above requirements. OR
Where an inflow for the remaining amount of Rs. 15 million is not probable, no contingent
asset should be disclosed.

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 CAF 7 – IAS 37

Part (iv) Reduction in future profit by Rs. 10m for the half year ending 31-12-2014:
No provision or disclosure is required for future operating losses as they arise from future
events not past events.

ANSWER 23
Zamil Limited
Page | 44 Accounting treatment and disclosure for the year ended 31 December 2014
Part (a) Claim for supply of inferior quality goods
 Claim to the extent of Rs. 6 million is accepted by the vendor, therefore, a claim
would be recognized as an asset by ZL as it is virtually certain that it will be received.
 For the probable claim amount of Rs. 2.8 million [(10-6)×70%], it should be treated as
a loss and charged to profit and loss account and a contingent asset amounting to
Rs. 2.8 million should also be disclosed, giving a brief description of the contingent
asset at the end of the reporting period.
 Recovery of Rs. 1.2 million [(10-6) ×30%] is not probable, therefore, it would be
charged to profit and loss account.

Part (b) Withdrawal of funds from ZL's bank accounts fraudulently

 Cash withdrawal before 31 December 2014 amounted to Rs. 7 million from ZL's bank
accounts is an adjusting event as the event existed on 31 December 2014 though it
was revealed after the year end. Cash lost to the extent of 80% is certain to be
received, therefore a claim of Rs.5.6 million (7*80%) would be recognized as an
asset. Remaining amount of Rs.1.4 million (7*20%) is no more receivable, therefore,
it would be charged to profit and loss account for the year ended 31 December 2014.
 Cash withdrawal of Rs.3 million is a non-adjusting event as it occurred after year end.
However, if the event is considered to be material, a disclosure should be made
along with the expected recovery related to it.

Part (c) Relocation of unit from Sukkur to Karachi

 A provision for restructuring cost is to be recognized, as a formal restructuring plan
has been finalized and approved by the management and a formal public
announcement was made prior to 31 December 2014. Therefore, a constructive
obligation has arisen on 1 December 2014.
 However, a provision should only be made for redundancy cost of Rs.3.58 million as
it pertains to the closing of Sukkur unit.
 Costs for staff training and relocation of staff relate to future conduct of the business
and should not be recorded in the year ended 31 December 2014.
 Salary of the existing operation manager should not be recorded as it is not
incremental cost, and would be incurred whether relocation takes place or not.

Part (d) Installation of safety equipment to carrying vehicles of ZL:

 For the year ended 31 December 2014, ZL is not required to make any provision for
liability due to non-installation of safety equipment to its chemical carrying vehicles,
as:
 There is no law requiring ZL to install the safety equipment.
 There is no constructive obligation to install the safety equipment, since ZL has
neither past practice nor any published policy in this respect.
 Although, decision has been made on 25 December 2014 to install the safety
equipment, cost would only be recorded on actual incurrence of cost.

Latest update: March 2020

 CAF 7 – IAS 37

ANSWER 24
Industrial Chemicals Limited
Accounting treatment and disclosures for the year ended 30 June2015
Provisions and contingent liability:
According to IAS 37, a provision shall be recognized when all of the following conditions are
met:
 There is a present obligation (legal or constructive) as a result of past event. Page | 45
 It is probable that outflow of resources will be required to settle the obligation.
 A reliable estimate can be made of the amount of the obligations.

In view of the above, a provision shall be made to the extent the above conditions are met as
explained under:

Part (i)
Rs. 12 million [OR Rs. 10.4 million (12×60%+8×40%)] for the pending claim of the worker as
it is most likely that ICL would require to pay this amount as advised by ICL’s lawyers. For
the remaining amount of Rs. 13 million (25–12) [OR Rs. 14.6 million (25–10.4)], it is not
probable that an outflow of economic benefits will be required. Therefore, a contingent
liability would be disclosed giving information as under:
 A brief nature of the contingent liability.
 Where practicable an estimate of finance liability and indication of uncertainties; and
 The possibility of any reimbursement

Part (ii)
Reimbursements:
According to IAS 37, 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 where it is virtually certain that
reimbursement will be received.
 The amount recognized in respect of the reimbursement shall not exceed the amount
of provision.
 The reimbursement receivable shall be treated as a separate asset.

In view of the above, accounting treatment and disclosure in respect of insurance claim will
be as under:

 Insurance claim to the extent of Rs. 14 million is accepted in principle by the insurance
company; therefore, it will be taken as ‘virtually certain to be received’. However, the
insurance claim to be recognized as receivable shall be restricted to Rs. 12 million (OR
Rs. 10.4 million) for which the provision is recorded.
 Recovery of the insurance claim to the extent of Rs. 2.0 million is probable, therefore, a
contingent asset would be disclosed for this amount giving information as under:
 A brief nature of the contingent asset; and
 An estimate of financial effect and indication of uncertainties.

Part (iii)
As regards the additional compensation of Rs. 1.5 million under consideration of the
management, neither provision nor disclosure shall be made as the obligation is neither legal
nor constructive as the matter is still under consideration and no formal intimation was made
that may create a valid expectation in this respect.

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 CAF 7 – IAS 37

ANSWER 25
Part (a)
2015 Financial Statements:
NL should have made a provision of Rs. 2 million because:
(i) NL had a present obligation as a result of past event;
(ii) The validity of customer's claim was confirmed by the company's lawyer which shows
Page | 46
that outflow will be required to settle the obligation
(iii) A reliable estimate of the amount of outflow was available.

2016 Financial Statements:

The settlement of the case in July 2016 was an adjusting event for the year ended 30 June
2016. The provision created in 2015 is to be reversed. The company should revise the
provision keeping in view of the cost of replacement less the amount that would be
recovered on disposal of faulty batteries.

Part (b)
2015 Financial Statements:
NL should disclose the recoverable damages as contingent assets because:
(i) IFRS does not allow recognition of a contingent asset in the financial statement;
(ii) an inflow of economic benefits is probable and is confirmed by the company's lawyer
(iii) NL should disclose the brief description of the nature of contingent assets and an
estimate of their financial effect i.e. inflow of Rs. 24 million.

2016 Financial Statements:

Since this is an adjusting event as subsequent to year ended 30 June 2016, the court has
decided to award a compensation of Rs. 30 million. After the court's order recovery of Rs. 30
million is virtually certain, as a result, it is no longer a contingent asset and it should be
recognized as an asset.

Part (c)
2015 Financial Statements:
Neither provisions nor disclosure should be made as there is no constructive or legal
obligation as on 30 June 2015 because:
(i) NL has no detailed formal plan for the disposal
(ii) NL has not made its decision public and consequently did not raise any valid expectation
in those affected

2016 Financial Statements:

The provision should be recognized because the obligating event is the communication of
the plan to the public which creates a valid expectation that the division will be closed.

However, the provision should only be recognised to the extent of redundancy cost. IAS-37
prohibits the recognition of future operating losses and staff training costs.

ANSWER 26
Event (i)
This is an adjusting post reporting event as it provides evidence of conditions that existed at
the end of the reporting period. The reasons for the competitor’s price reduction will not have
arisen overnight, but will normally have occurred over a period of time, may be due to
superior investment in technology.

An inventory write down of Rs. 2.5 million should be recognized and the amount included as
inventory on the Statement of Financial Position reduced to Rs. 12.5 million.

Latest update: March 2020

 CAF 7 – IAS 37

Event (ii)
The provision should be recognized because the obligating event is the communication of
event to the public which creates a valid expectation that the division will be closed.

However, the provision should only be recognized to the extent of redundancy costs. IAS
prohibits the recognition of future operating losses, staff training and profits on sale of
assets. Page | 47

Event (iii)
This is a non-adjusting event because the burglary and theft of consumable stores occurred
after reporting date. However, if the event is material, it should be disclosed in the financial
statements unless the loss is recoverable from the insurance company.

Event (iv)
The drop in value of investment in shares is a non-adjusting event. Since the legislation was
announced after the reporting date, the event is not a past event. However, if the amount is
material, it should be disclosed in the financial statements.

Event (v)
This is an adjusting event as it provides evidence of conditions that existed at the end of the
reporting period. The insolvency of a debtor and the inability to pay usually builds up over a
period of time and it can therefore be assumed that it was facing financial difficulty at year-
end.

A bad debts expense of Rs. 1.5 million should be recognized in SOCI.

Event (vi)
It is a non-adjusting event because the declaration was announced after the yearend and
there was no obligation at year end. Details of the bonus shares declaration must, however,
be disclosed.

ANSWER 27
Litigation for damages (Part 1)
Under IAS37, a provision should only be recognized when:
 An entity has a present obligation as a result of a past event
 It is probable that an outflow of economic benefits will be required to settle the
obligation
 A reliable estimate can be made of the amount of the obligation.

Applying this to the facts given:

 Georgina’s legal advisors have confirmed that there is a legal obligation. This arose
from the past event of the sale, on 1 September 2015 (i.e. before the year-end).
 Probable is defined as ‘more likely than not’. The legal advisors have confirmed that
it is likely that the claim will succeed.
 A reliable estimate of Rs.500,000 has been made.

Therefore a provision of Rs.500,000 should be made.

Counter-claim
IAS37 requires that such a reimbursement should only be recognized where receipt is
‘virtually certain’. Since the legal advisors are unsure whether this claim will succeed no
asset should be recognized in respect of this claim.

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 CAF 7 – IAS 37

Claim for unfair dismissal (Part 2)

In this case, the legal advisers believe that success is unlikely (i.e. possible rather than
probable). Therefore this claim meets the IAS37 definition of a contingent liability:
 a possible obligation
 arising from past events
 whose existence will be confirmed only by the occurrence or nonoccurrence of
Page | 48 one or more uncertain future events.

The liability is a possible one, which will be determined by a future court case or tribunal. It
did arise from past events (the dismissal had taken place by the year end).

This contingent liability should be disclosed in the financial statements (unless the legal
advisors believe that the possibility of success is in fact remote, and then no disclosure is
necessary).

Returns (Part 3)
Applying the IAS37 conditions in (1) to the facts given:
 Although there is no legal obligation, a constructive obligation arises from Georgina’s
past actions. Georgina has created an expectation in its customers that such refunds
will be given.
 As at the year end, based on past experience, an outflow of economic benefits is
probable.
 A reliable estimate can be made. This could be 1% × 400,000 but since the returns
are now all in the actual figure of Rs.3,500 can be used.

Therefore a provision of Rs.3,500 should be made.

Closure of division (Part 4)

Applying the above IAS37 conditions in (1) to the facts given:
 A present obligation exists because at the year-end there is a detailed plan in place
and the closure has been announced in the press.
 An outflow of economic benefits is probable.
 A reliable estimate of Rs.300,000 has been made.

However, IAS37 specifically states in respect of restructuring that any provision should
include only direct expenses, not ongoing expenses such as staff relocation or retraining.
Therefore a provision of Rs.250,000 (300,000 – 50,000) should be made.

ANSWER 28
Part (a)
The event is an accident, and since it happened before the year end, it is a past event.
However, there is no present obligation since:
(i) There is no law requiring the company to clean the canal.
(ii) There is no constructive obligation to clean the river since:
 A public statement has not been made;
 There is no established pattern of past practice as this was the first time the
company faced such a situation.
Although the company has decided to clean up the river and even has a reliable estimate of
the costs thereof, no liability or provision should be recognized in the current year because:
 The decision was taken after year end; and
 The decision was not yet made public.

Latest update: March 2020

 CAF 7 – IAS 37

Part (b)
It is a non-adjustable event because the event due to which the net realizable value (NRV) of
stock has fallen, arose after the reporting date.

However, if this event is material, the company should disclose the decline in NRV in its
financial statement for the year ended June 30, 2015.
Page | 49
Part (c)
The company should make the provision because:
(i) The company has a present obligation because of past event
(ii) The claim of the customer is valid and is confirmed by the company's inspection
team which shows that an outflow will be required to settle the obligation.
(iii) The amount of outflow is reliably estimated i.e. Rs. 2 million.

Since the company is certain of recovery from the vendor, it should:

(i) Disclose it as a separate asset.
(ii) Recognize a receivable but the same should not exceed the amount of the
related provision i.e. Rs. 2.0 million.

ANSWER 29
Part (i)
Provision must be made for estimated future claims by customers for goods already sold.
The expected value i.e. Rs. 10 million ([Rs. 150m x 2%] + [Rs. 70m x 10%]) is the best
estimate of the provision.
Part (ii)
Warehouse A: It is an onerous contract. as the warehouse has been sublet at a loss of Rs.
200,000 per month. QIT should therefore create a provision for the onerous contract that
arises on vacating the warehouse. This is calculated as the excess of unavoidable costs of
the contract over the economic benefits to be received from it. Therefore, QIL should
immediately provide for the amount of present value of Rs. 13.2 million. [5.5 years x 12
month x Rs. 200,000] in its financial statements i.e. for the year ended June 30, 2015
Warehouse B: It is not an onerous contract because the warehouse has been sublet at
profit. Hence this would require no adjustment.

Part (iii)
A provision is to be made by QIL against employees claim as:
(a) There is a present obligation (legal or constructive) as a result of a past event; i.e.
accident occurred on June 15, 2015.
(b) It is probable that outflow of resources will be required to settle the obligation; and
(c) A reliable estimate can be made of the amount of the obligation.
The amount of provision shall be Rs. 2.0 million i.e. the most probable amount as
determined by the lawyer.
Part (iv)
A provision of Rs. 0.4 million is required in relation to penalty for March 1 to June 30, 2015
because at the reporting date there is a present obligation in respect of a past event.

The reimbursement of penalty amount from the vendor shall be recognized when and only
when it is virtually certain that reimbursement will be received if the entity settles the
obligation. The reimbursement should be treated as a separate asset in the statement of
financial position. However, in profit and loss statement, the expense relating to a provision
may be netted off with the amount recognized as recoverable, if any.

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 CAF 7 – IAS 37

ANSWER 30
Part (i)
Although the debt owing by the customer existed at the reporting date, the customer’s
inability to pay did not exist at that point. This condition only arose in January 2016 after the
fire.
Page | 50 Thus, this is a non-adjusting event. However, if it is material for the financial statements, the
following disclosure should be made.
 Nature of the event
 An estimate of its financial effect

Part (ii)
The amount withdrawn before year end i.e. Rs. 1.5 million is an adjusting event as although
it was discovered after year end it existed at the year end. However, since 60% has been
recovered subsequently, Rs. 0.6 million would be provided.

The further withdrawal of Rs. 6.0 million is a non-adjusting event as it occurred after year
end.

However, if the events are considered material the following disclosures should be made:
 Nature of the event
 The gross amount of contingency
 The amount recovered subsequently

Part (iii)
SL should not recognize the contingent gain until it is realized. However, if recovery of
damages is probable and material to the financial statements, SL should disclose the
following facts in the financial statements:
 Brief descript ion of the nature of the contingent asset
 An estimate of the financial effect.

Part (iv)
SL should make a provision of the amount of Rs. 1 million being most likely outcome
because (expected value is more suitable when there is large population of similar items):
 it is a present obligation as a result of past event;
 it is probable that an outflow of resources embodying economic benefits will be
required to settle the obligations; and
 a reliable estimate can be made of the amount.

In addition, SL should disclose the following in the notes to the financial statements:
 Brief nature o f the contingent liability
 The amount of contingency
 An indication of the uncertainties relating to the amount or timing of any outflow.

ANSWER 31
Part (a)
NPL should recognize following provision / expense as on 30 June 2017:
Rs. in million
Provision for penalty (Note 1) 05
Expense related to inventories recognized on lower of cost or NRV
[14 minus 11 (15–4)] (Note 2) 03
Provision for onerous contract [45–55] (Note 3) 10
18

Latest update: March 2020

 CAF 7 – IAS 37

Note 1: Supply for June 2017 was made after delay of 15 days so as per terms of
agreement provision for penalty should be made for this adjusting event.

Note 2: Since cost incurred till 30 June 2017 (Rs. 14 million) is higher than the net realizable
value of inventory i.e Rs.11 million (selling price of 15 million less 4 million cost to be
incurred) expense of Rs. 3 million related to write-down of inventory to NRV should be Page | 51
recognized.

Note 3: Since estimated cost of Rs. 55 million which would need to be spent is more than
the total revenue of Rs. 45 million for last 3 deliveries, the contract is considered as onerous
and the provision should be made at Rs. 10 million that is lower of cost of fulfilling it (Rs. 10
million i.e 55 – 45 ) or penalty arising from failure to fulfill it (Rs 20 million).

Part (b)
Claim regarding NPL’s negligence
As on 30 June 2017 NPL should recognize a provision for ten injured employees because at
reporting date there is present obligation in respect of past event (injuries suffered from
explosion occurred before year end). NPL’s lawyers estimate that probability of NPL being
declared negligent is 80% which is considered as probable. Therefore, provision should be
made for total payout of Rs 10 million (1 million for each employee).

According to the terms of insurance policy, 80% of the cost is recoverable from insurance
company so it is virtually certain that reimbursement will be made. According to IAS 37,
NPL should recognize a separate asset (receivable) of Rs. 8 million (10 million × 80%). In
the statement of comprehensive income provision may be presented net of reimbursement
amount.

Claim seeking compensation for the stress

As per legal adviser, there is only 30% chance that the claims lodged against the company
for undue stress will succeed so payment of Rs 2.8 million (0.7 million × 4) is possible (not
a present) obligation. Consequently, provision is not required and NPL should disclose this
amount as contingent liability giving brief description of the event and estimate of financial
effect.

Part (c)
As on 30 June 2017, NPL should recognize expense of Rs. 1.2 million (0.4×3) in relation to
penalty for non-compliance of new law from 1 April to 30 June 2017 because at the reporting
date there is a present obligation (payment of penalty) in respect of a past event (non-
compliance of statutory requirement). NPL should disclose the penalty amount in its financial
statement.

Since the reimbursement of penalty amount from the vendor is probable, the reimbursement
of only two months (May and June 2017) of Rs. 0.8 million (0.4×2) should be disclosed as a
contingent asset giving brief description of the event and estimate of financial effect.

ANSWER 32
(i) In given scenario, present obligation was not existing at year end as the obligating
event in this case is the actual sales of the product rather than the publishing of
coupon in newspaper. Therefore, neither provision nor disclosure of contingent
liability are required in the ML’s financial statements for the year ended 31 December
2017.

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 CAF 7 – IAS 37

(ii) Determination of the sale price after the reporting period for an asset sold, where the
sale had been made before the year end is considered as an adjusting event under
IAS 10. Consequently, ML is required to book receivable of Rs. 1.5 million at year
end. Further, gain or loss on sale of machine has to be calculated by taking into
account of such receivable.

Page | 52 (iii) IAS 10 states that if an entity receives information after the reporting period about
conditions that existed at the end of the reporting period, it shall update disclosures
that relate to those conditions, in the light of the new information. In light of above,
ML is required to disclose the contingent liability in light of revised opinion of ML’s
lawyer i.e. 40% chances that the court would award compensation of Rs. 2 million to
the effected worker.

(iv) Announcement of restructuring plan to those employees who would be affected by

the plan raises constructive obligation on ML. According to restructuring plan,
management expects that 25 employees would accept the offer so provision/liability
should be made for Rs. 25 million (Rs. 1 million × 25 employees) irrespective of
employees who have already opted the scheme till now.

ANSWER 33
Introduction
All four scenarios relate to the rules of IAS 37 Provisions, contingent liabilities and
contingent assets. In each scenario, the key issue is whether or not a provision should be
recognised.

Under IAS 37, a provision should only be recognised when three conditions are met:
 there is a present obligation as a result of a past event; and
 it is probable that a transfer of economic benefits will be required to settle the obligation;
and
 a reliable estimate can be made of the amount of the obligation.

Factory closure
As the factory closure changes the way in which the business is conducted (it involves the
relocation of business activities from one part of the country to another) it appears to fall
within the IAS 37 definition of a restructuring.

The key issue here is whether the group has an obligation at the end of the reporting period
to incur expenditure in connection with the restructuring. There is clearly no legal obligation,
but there may be a constructive obligation. IAS 37 states that a constructive obligation only
exists if the group has created valid expectations in other parties such as employees,
customers and suppliers that the restructuring will actually be carried out. As the group is still
in the process of drawing up a formal plan for the restructuring and no announcements have
been made to any of the parties affected, there cannot be an obligation to restructure. A
board decision alone is not sufficient. Therefore no provision should be made.

If the group starts to implement the restructuring or makes announcements to those affected
after the end of the reporting period but before the accounts are approved by the directors it
may be necessary to disclose the details in the financial statements as a non-adjusting post
event after the reporting period in accordance with IAS 10. This will be the case if the
restructuring is of such importance that non-disclosure would affect the ability of the users of
the financial statements to reach a proper understanding of the group’s financial position.

Latest update: March 2020

 CAF 7 – IAS 37

Operating lease
The lease contract appears to be an ‘onerous contract’ as defined by IAS 37 as the
unavoidable costs of meeting the obligations under it exceed the economic benefits
expected to be received from it.

Because the enterprise has signed the lease contract there is a clear legal obligation and the
enterprise will have to transfer economic benefits (pay the lease rentals) in settlement. Page | 53
Therefore, the group should recognise a provision for the net present value of the remaining
lease payments.

In principle, a corresponding asset may be recognised in relation to the future rentals

expected to be received, if these receipts are virtually certain. The current arrangement with
the charity generates only nominal rental income and so the asset is unlikely to be material
enough to warrant recognition.

The chances of renting the premises at a commercial rent are less than 50% and so no
further potential rent receivable may be taken into account as the outcome is not virtually
certain and so recognition would not be prudent.

The financial statements should disclose the carrying amount of the onerous lease provision
at the end of the reporting period, a description of the nature of the obligation and the
expected timing of the lease payments. Disclosure should also be made of the contingent
assets where the amount of any expected rentals receivable from sub-letting are material
and the likelihood is believed probable.

Legal proceedings
It is unlikely that the group has a present obligation to compensate the customer; therefore
no provision should be recognised. However, there is a contingent liability. Unless the
possibility of a transfer of economic benefits is remote, the financial statements should
disclose a brief description of the nature of the contingent liability, an estimate of its financial
effect and an indication of the uncertainties relating to the amount or timing of any outflow.

Environmental damage
It is clear that there is no legal obligation to rectify the damage. However, through its
published policies, the group has created expectations on the part of those affected that it
will take action to do so. There is, therefore, a constructive obligation to rectify the damage
and a transfer of economic benefits is probable.

The group must recognise a provision for the best estimate of the cost. As the most likely
outcome is that more than one attempt at re-planting will be needed, the full amount of Rs.
30 million should be provided. The expenditure will take place sometime in the future, and so
the provision should be discounted at a pre-tax rate that reflects current market assessments
of the time value of money and the risks specific to the liability.

The financial statements should disclose the carrying amount at the end of the reporting
period, a description of the nature of the obligation and the expected timing of the
expenditure. The financial statements should also give an indication of the uncertainties
about the amount and timing of the expenditure.

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 CAF 7 – IAS 37

ANSWER 34
(i) As on 31 December 2018, OL should recognize a provision for warranty service to be
provided as there is a present obligation as a result of a past event (sale of A-1 and
B-1 in 2018). The amount of provision would be:
 Rs. 2 million (4×50%) in respect of A-1 as OL is liable to SL for 50% cost of
services.
Page | 54
 Rs. 7 million (entire cost) in respect of B-1 as OL is responsible to the customers
for providing warranty services.

OL is required to disclose a contingent liability for remaining warranty cost of A-1

(which should be incurred by SL) as OL would be responsible for it in case of SL’s
default. (Joint and several liability)
Further OL should recognize a separate asset (receivable) to the extent that
reimbursements from SL in respect B-1 are virtually certain. In the statement of profit
or loss, the expense relating to warranty services may be presented net of the
amount recognized as receivable (reimbursement).

(ii) (As on 31 December 2018, OL is required to record a liability of Rs. 5 million as this
has already been approved by OL. In respect of remaining amount of the claim, a
provision of Rs. 6 million shall be made as it is most likely that OL would require to
pay this amount as advised by OL’s lawyers.

Further OL should recognize a separate asset (receivable) to the extent of Rs. 9

million as it is accepted in principle by the supplier. Therefore, it will be taken as
‘virtually certain to be received’. In the statement of profit or loss, the expense
relating to the provision may be presented net of amount recognized as receivable
(reimbursement).

However, recovery of the claim to the extent of Rs. 3 million is probable, therefore, a
contingent asset would be disclosed.

(iii) Introduction of new alternative drug with better results is an indication of reduction in
value of existing medicine kept in stock. It is more evident by subsequent sales of
such units at lower price i.e. Rs. 8,000 with 10% commission to distributors.
According to IAS 2, inventory should be recorded at lower of cost or NRV (i.e.
estimated selling price less estimated costs necessary to make the sale). So OL is
required to carry entire stock of this medicine at NRV i.e. Rs. 36 million [5,000×7,200
(8,000 – 800)].

ANSWER 35
Part (i)
A provision of Rs. 20 million (i.e. 40% of Rs. 50 million) needs to be recognised as it meets
the required criteria:
(a) There is present obligation arising from the past event i.e. fire incident in June 2019.
(b) Outflow of economic benefits is probable i.e. 70% chances of being found negligent.
(c) Reliable estimate is also available i.e. 40% of amount claimed.

Part (ii)
A provision for restructuring of Rs. 20 million needs to be recognised as it meets the required
criteria:
(a) There is present constructive obligation at year end as detailed formal plan has
been approved and announced to public prior to 30 June 2019 creating valid
expectations.

Latest update: March 2020

 CAF 7 – IAS 37

(b) Outflow of economic benefits is expected as entity has estimated costs to be

incurred.
(c) Only costs directly attributable to restructuring are to be included in measurement
i.e. Rs. 20 million in respect of redundancy payments.

Cost of relocation i.e. cost of moving equipment to new location and compensation to
employees for relocation are not to be included. Page | 55

Salary of existing operation manager is not incremental cost and is an expense relating to
ongoing activities of the entity.

Part (iii)
IAS 2 is applicable to inventory already held in stock. A loss for write down to NRV is
required i.e. 6,000 units x Rs. (500 – 350) = Rs. 900,000 loss.

A firm commitment to buy items in future at unfavorable terms is an onerous contract. A

provision is required to be made:
(a) There is present legal obligation due to binding contract.
(b) Outflow of economic benefits is probable either in form of penalty or buying the
product at higher rate.
(c) Honoring the contract would result in loss of Rs. 3 million (Rs. (500 – 350) x 10,000
units x 2 months) and breach would result in penalty of Rs. 4 million. A rational
choice is lower loss for which provision is to be recognised.

Part (iv)
In the given scenario, warranty period is divided into two i.e. First eight months and
subsequent four months. Both periods are discussed separately below:

First 8 months:
Since SL is responsible for warranty claim arising in this period and no cost is charged by SL
so no provision is required in TL’s books. However, since TL is responsible if SL does not
honour its obligation for this warranty period, TL should disclose this fact as contingent
liability.

Subsequent 4 months:
Since SL charges an amount from TL depend upon nature of defect, provision should be
recorded in TL’s books as there is present obligation as a result of past event (Sale of
Product).

Computation is as follows:
Nature of defect % defective units No. of units Rs. per unit Rs.
Minor 6% 720 500 360,000
Moderate 10% 1,200 1,000 1,200,000
Major 5% 600 2,500 1,500,000
3,060,000
Less: Already claimed (1,200,000)
Provision to be made 1,860,000

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 CAF 7 – IAS 37

Page | 56

Latest update: March 2020

 CAF 7 – IAS 37

ICAP OBJECTIVE BASED QUESTIONS

01. Which of the following would NOT be valid reason for recording a provision?
(a) A company has a policy of cleaning up any environmental contamination caused by its
operations but is not legally obliged to do so.
(b) A company is leasing an office building for which it has no further use. However, it is tied
into the lease for another year.
Page | 57
(c) A company is closing down a division. The Board has prepared detailed closure plans
which have been communicated to customers and employees.
(d) A company has acquired a machine which requires a major overhaul every three years.
The cost of the first overhaul is reliably estimated at Rs. 1,200,000.

02. Which of the following statements are correct in accordance with IAS 37 Provisions, contingent
liabilities and contingent assets?
(i) Provisions should be made for both constructive and legal obligations.
(ii) Discounting may be used when estimating the amount of a provision.
(iii) A restructuring provision must include the estimated costs of retraining or relocating
continuing staff.
(iv) A restructuring provision may only be made when a company has a detailed plan for the
restructuring and has communicated to interested parties a firm intention to carry it out.
(a) All four statements are correct
(b) (i), (ii) and (iv) only
(c) (i), (iii) and (iv) only
(d) (ii) and (iii) only

03. Talal Limited (TL) year end is 30 September 2014 and the following potential liabilities have
been identified. Which TWO of the following should TL recognise as liabilities as at 30
September 2014?
(a) The signing of a non-cancellable contract in September 2014 to supply goods in the
following year on which, due to a pricing error, a loss will be made.
(b) The cost of a reorganisation which was approved by the board in August 2014 but has not
yet been implemented, communicated to interested parties or announced publicly
(c) An amount of deferred tax relating to the gain on the revaluation of a property during the
current year. TL has no intention of selling the property in the foreseeable future.
(d) The balance on the warranty provision which related to products for which there are no
outstanding claims and whose warranties had expired by 30 September 2014

04. The following information has been extracted from the records of Simple Limited (SL):
1. SL operates a chemical plant which has polluted the surrounding countryside. The Board of
Directors has decided to clean up the environmental damage. This decision has been
published in the local press on 15 June 2018. However, SL is not legally required to clean
up the environmental damage.
2. SL has decided to close down one of its operating segment. However, the decision was
made public after 30 June 2018.
In the financial statements for the year ended 30 June 2018, SL should recognize a provision for
the best estimate of costs in respect of:
(a) (1) only
(b) (2) only
(c) Neither (1) nor (2)
(d) Both (1) and (2)
05. In a review of its provisions for the year ended 31 March 2015, entity’s assistant accountant has
suggested the following accounting treatments:
(i) Based on past experience, a Rs. 200,000 provision for unforeseen liabilities arising after
the year end.
(ii) The partial reversal (as a credit to the statement of profit or loss) of the accumulated
depreciation provision on an item of plant because the estimate of its remaining useful life
has been increased by three years.
(iii) Providing Rs. 1 million for deferred tax at 25% relating to a Rs. 4 million revaluation of
property during March 2015 even though entity has no intention of selling the property in
the near future.

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 CAF 7 – IAS 37

Which of the above suggested treatments of provisions is/are permitted by IFRS Standards?
(a) (i) only
(b) (i) and (ii)
(c) (ii) and (iii)
(d) (iii) only

06. Canon Limited (CL) is being sued by a customer for Rs. 2 million for breach of contract over a
Page | 58 cancelled order. CL has obtained legal opinion that there is a 20% chance that CL will lose the
case. Accordingly, CL has provided Rs. 400,000 (Rs. 2 million × 20%) in respect of the claim.
The unrecoverable legal costs of defending the action are estimated at Rs. 100,000. These have
not been provided for as the case will not go to court until next year.
What is the amount of the provision that should have been made by CL in respect of above
information?
Rs. ___________

07. During the year Platinum Limited acquired an iron ore mine at a cost of Rs. 600 million. In
addition, when all the ore has been extracted (estimated ten years' time) the company will face
estimated costs for landscaping the area affected by the mining that have a present value of Rs.
200 million. These costs would still have to be incurred even if no further ore was extracted.
At which amount the mine should be recognised?
Rs. ___________

08. Titanium Limited (TL) is preparing its financial statements for the year ended 30 September
2017. TL is facing a number of legal claims from its customers with regards to a faulty product
sold. The total amount being claimed is Rs. 3.5 million. TL’s lawyers say that the customers
have an 80% chance of being successful.
According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, what amount, if
any, should be recognised in respect of the above in TL’s statement of financial position as at 30
September 2017?
Rs. ___________

09. Alpha Limited has a year end of 31 December 2014. On 15 December 2014 the directors
publicly announced their decision to close an operating unit and make a number of employees
redundant. Some of the employees currently working in the unit will be transferred to other
operating units within Alpha Limited.
The estimated costs of the closure are as follows: Rs. 000
Redundancy costs 800
Lease termination costs 200
Relocation of continuing employees to new locations 400
Retraining of continuing employees 300
1,700
What is the closure provision that should be recognised?
Rs. ___________

10. On 1 October 2013, X Limited commenced drilling for oil in an undersea oilfield. The extraction
of oil causes damage to the seabed which has a restorative cost (ignore discounting) of Rs.
10,000 per million barrels of oil extracted. X Limited extracted 250 million barrels of oil in the
year ended 30 September 2014.
X Limited is also required to dismantle the drilling equipment at the end of its five-year licence.
This has an estimated cost of Rs. 30 million on 30 September 2018. X Limited’s cost of capital is
8% per annum and Re. 1 has a present value of 68 paisa in five years’ time.
What is the total provision (extraction plus dismantling) which X Limited would report in its
statement of financial position as at 30 September 2014 in respect of its oil operations?
Rs. ____________

Latest update: March 2020

 CAF 7 – IAS 37

OBJECTIVE BASED ANSWERS

01. (d) The cost of the overhaul will be capitalised when it takes place. No
obligation exists before the overhaul is carried out. The other options would
all give rise to valid provisions.

02. (b) A restructuring provision must not include the costs of retraining or Page | 59
relocating staff.

03. (a) & (c) In (b) the obligation does not exist as it has not been communicated to
those affected by it. In (d) there is no obligation as warranty period has
expired.

04. (a) In (2) the decision was made public after year end, so it is non-adjusting
event.

05. (d) Deferred tax relating to the revaluation of an asset must be provided for
even if there is no intention to sell the asset in accordance with IAS 12
Income Taxes.

06. Rs. 100,000 Loss of the case is not 'probable', so no provision is made, but the legal
costs will have to be paid so should be provided for.

07. Rs. 800 Rs. 600 million + Rs. 200 million = Rs. 800 million
million

08. Rs. 3,500,000 The amount payable relates to a past event (the sale of faulty products) and
the likelihood of payout is probable (i.e. more likely than not). Hence, the full
amount of the payout should be provided for.

09. Rs. 1,000,000 The costs associated with ongoing activities (relocation and retraining of
employees) should not be provided for.

10. Rs. Extraction provision at 30 September 2014 is Rs. 2.5 million (250 × 10).
24,532,000
Dismantling provision at 1 October 2013 is Rs. 20.4 million (30,000 × 0.68).
This will increase by an 8% finance cost by 30 September 2014
= Rs. 22,032,000.
Total provision is Rs. 24,532,000.

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