ACC2001 FINANCIAL ACCOUNTING

Trimester 1 AY2020/21

Lecture 6: Events after the Reporting Period,

Provisions and Contingencies
Learning Objectives

Upon completing this topic you shall be able to:

1. Understand the applicable standards and scope

2. Explain what events after the reporting period are
3. Understand and account for adjusting events/non-
adjusting events
4. Distinguish between current and non-current liabilities
5. Explain and account for provisions, contingent liabilities
and contingent assets

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Applicable Standards and Scope

SFRS(I) 1-10 Events after the reporting period prescribes the

accounting treatment for, and disclosure of, events after the balance
sheet date

IFRIC 17 Distributions of Non-cash Assets to Owners provides guidance

on the disclosure requirements if an entity declares a dividend to
distribute a non-cash asset to owners after the balance sheet date

Events after the reporting period are those events, favourable and
unfavourable, that occur between the end of the reporting period and
the date when the financial statements are authorised for issue.

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Applicable Standards and Scope
SFRS(I) 1-37 Provisions, Contingent Liabilities and Contingent Assets
ensures that appropriate recognition criteria and measurement bases are
applied to provisions, contingent liabilities and contingent assets and that
sufficient information is disclosed in the notes to enable users to understand
their nature, timing and amount.
Exception:
a) those resulting from executory contracts,
except where the contract is onerous; and
b) those covered by another Standard ( see next slide)

❖ Executory contracts are contracts under which

▪ neither party has performed any of its obligations or
▪ both parties have partially performed their obligations to an equal extent

❖ An onerous contract 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.
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 Applicable Standards and Scope
• Do not Apply SFRS(I) 1-37 for those covered by another
Standard, including:
– income taxes (see SFRS(I) 1-12 Income Taxes);
– leases (see SFRS(I) 16 Leases);
– employee benefits (see SFRS(I) 1-19 Employee Benefits);
– insurance contracts (see SFRS(I) 4 Insurance Contracts);
– contingent consideration of an acquirer in a business combination
(see SFRS(I) 3 Business Combinations); and
– revenue from contracts with customers (see SFRS(I) 15 Revenue
from Contracts with Customers). However, as SFRS(I) 15 contains
no specific requirements to address contracts with customers that
are, or have become, onerous, this Standard applies to such cases.

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Events after the reporting period

When are financial statements authorised for issue?

• Different entities may have different authorization process for issuing

the financial statements

• It could be on the date of issue, not the date when shareholders

approve the financial statements

• It could be when the management authorizes them for issue to the

supervisory board

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Events after the reporting period - Example
On 6 March 2012, the management of an entity completed draft financial statements
for the year ended 31 December 2011.

• On 12 March 2012, the board of directors reviewed the financial statements and
authorised them for issue.

• The entity announced its profit and selected other financial information on 13 March
2012.

• The financial statements were made available to shareholders and others on 20

March 2012.

• The shareholders approved the financial statements at their annual meeting on 10

April 2012 and the approved financial statements were then filed with a regulatory
body on 9 April 2012.

When were the financial statements authorized for issue?

The financial statements were authorised for issue on 12 March 2012 (date of board
authorisation for issue) 7
Events after the reporting period

Events after the reporting period are different from subsequent events:

“Events after the reporting period” is an accounting concept, while “subsequent

events” is an auditing concept.

The date of the auditors’ report is not necessary the same as the date when the
financial statements are authorised for issue.

Subsequent events cover facts discovered after the date of the auditors’ report which
could be many years after the date of the auditors’ report.

Types of Events After the reporting period:

• Adjusting events
those that provide evidence of conditions that existed at the end of the reporting
period

• Non-adjusting events
those that are indicative of conditions that arose after the reporting period
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Events after the reporting period

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Recognition and Measurement:
Adjusting Events
• An entity adjusts the amounts recognised in its financial statements to reflect
adjusting events after the BS date.

• Either adjust the amounts recognised in its financial statements, or to recognise

items that were not previously recognised.

Examples of Adjusting Events:

• Settlement of a court case after BS date

• Newly received information after BS date

• Determination after reporting date of the cost of assets purchased, or the proceeds
from assets sold, before BS date

• Determination of profit sharing or bonus payments if the entity had a present

legal or constructive obligation at reporting date to make such payments as a
result of events before BS date
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Recognition & Measurement:
Adjusting Events Example

Discovery of Fraud or Errors

A few days before the directors of DEF Limited approve the financial statements for the
year ended 31 December 2012, Mr. Chan, DEF Limited’s managing director, has discovered
that the general manager of one of the subsidiaries in DEF Limited has
misappropriated cash of $10 million, which represents a material amount of assets of DEF
Limited.

Further investigation of the matter indicates that the money was stolen in December 2012.

Determine whether the above is an adjusting or non-adjusting event? Explain your answer.

What, if any, is the impact on DEF Limited’s financial statements for the year ended 31
December 2012?

This is an adjusting event because the misappropriation of $10 million occurred before the
balance sheet date.
Since the amount of $10 million is material, DEF Limited is required to adjust the
appropriated amount in its financial statements for the year ended 31 December 2012.
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Recognition & Measurement:
Non-Adjusting Events

An entity does not adjust the amounts recognised in its current

period’s financial statements to reflect non-adjusting events.

An entity discloses the nature of the event and an estimate of its

financial effect, or a statement that such an estimate cannot be
made for each material category of non-adjusting events.

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Recognition & Measurement:
Non-Adjusting Events

Non-adjusting events examples

• A decline in market value of investments

• Destruction of a major production plant or inventories by a fire or other natural
disasters after reporting date
• Discontinuing operations.
• Purchases, disposals and expropriation of major assets
• Major ordinary share transactions and potential ordinary share transactions after
reporting date
• Business combination after reporting date or dispose of a major subsidiary
• Significant commitments or contingent liabilities after BS date
• for example, by signing an agreement to acquire some significant assets
• Dividends declared to holders of equity instruments after BS date
• Commencing major litigation arising solely out of events that occurred after BS date

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Recognition & Measurement:
Non-Adjusting Events

A Decline in Market Value of Investments

• ABC Company’s financial assets include 1,000,000 ordinary shares of XYZ Company
Ltd (XYZ), which is categorised under “Financial assets at fair value through profit or
loss”.

• XYZ is a high technology company listed on the Stock Exchange and was trading
actively in the range of $10 and $10.5 per share on 31 December 2011, ABC
Company’s BS date.

• Subsequently on 3 January 2012, XYZ’s shares dropped significantly to about $5 per

share due to a competitor’s launching of a technological break-through product that
makes the company’s major product obsolete immediately.

• Determine whether it is necessary to adjust ABC Company’s financial statements for

the year ended 31 December 2011?

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Recognition & Measurement:
Non-Adjusting Events

This is a non-adjusting event because the significant decline in market value of

ABC Company’s investment in XYZ shares was due to circumstances that have
occurred after BS date and does not relate to the condition of the investments
at BS date.

ABC Company should not adjust the amounts recognised for the investments
in shares in its financial statements.

ABC company needs not update the amounts disclosed for the investment as
at the 31 December 2011, although it may need to give additional disclosure
of the decline in value under the disclosure requirements of SFRS(I) 1-10.

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Recognition & Measurement:
Non-Adjusting Events

An entity does not recognise dividends declared after the reporting

period as a liability at the end of the reporting period

No recognition even if an entity maintains a good record of ordinary

dividend payments and adopts a stable dividend strategy because the
existence of a good record of dividend payments and an established
dividend policy does not create a valid expectation or an obligation.

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 Going Concern

• An entity shall not prepare its financial statements on a going concern basis
if management determines after the reporting period either that
- it intends to liquidate the entity or to cease trading, or that
- it has no realistic alternative but to do so.

• Deterioration in operating results and financial position after the reporting

period may indicate a need to consider whether the going concern
assumption is still appropriate. If the going concern assumption is no longer
appropriate, the effect is so pervasive that this Standard requires a
fundamental change in the basis of accounting, rather than an adjustment
to the amounts recognised within the original basis of accounting.

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Disclosure

For date of authorisation for issue, disclose the date when the financial statements
were authorized for issue and who gave that authorization

• Update disclosure about conditions at BS date

• For non-adjusting events, disclose the nature of the event and an estimate of its
financial effect, or a statement that such an estimate cannot be made for each
material category of non-adjusting event

For declaration of a dividend to distribute a noncash asset, IFRIC 17 Distributions of

Non-cash Assets to Owners requires the entity to disclose the nature of the asset to
be distributed the carrying amount of the asset to be distributed as of the balance
sheet date; and the estimated fair value of the asset to be distributed as of the
balance sheet date, if it is different from its carrying amount, and the information
about the method used to determine that fair value

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Characteristics of Liabilities

. . . Result in
. . . Arising
Present an out flow of
from past
Obligation . . . resources in
events . . .
the future.

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Current Liabilities

LIABILITIES

Current Liabilities Long-term Liabilities

Obligations payable within one

year or one operating cycle,
whichever is longer.

Other situations:
For trading purposes, or does not
have the right to defer settlement
for at least 12 months
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A Closer Look at the Current &
Noncurrent Classification

The classification of financial liabilities requires the consideration of

 The terms of contract including the date of settlement,

 The right of the creditor to call back the loan,

 The right of the borrower to reschedule the loan repayment, and

 The provision of a grace period in the event that the borrower

breaches a covenant in the debt agreement etc.

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A Closer Look at the Current &
Noncurrent Classification

Current maturities of long-term obligations are usually

reclassified and reported as current liabilities if they are payable
within the upcoming year (or operating cycle, if longer than a
year).

Debt that is callable (due on demand) by the lender in the

coming year, (or operating cycle, if longer than a year) should be
classified as a current liability, even if the debt is not expected
to be called.

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A Closer Look at the Current &
Noncurrent Classification

Conversely, even if the obligation is due within a shorter period, the

long-term classification applies if the borrowing entity expects and has
the discretion to refinance or roll over an obligation for at least 12
months after the reporting period.

If the debt becomes callable due to a default (i.e. by violation of contract

covenant), and the creditor extends a grace period, the long-term
classification would still apply if the following conditions are met
The grace period ends at
It is probable that the
The lender agrees to the least twelve months after
borrower can make
grace period on or before the reporting period,
rectification of the
the end of the reporting during which the lender
violation within the
period cannot demand
extended grace period
immediate repayment

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Short-Term Obligations Expected
to be Refinanced
A company may reclassify a short-term liability as
long-term only if two conditions are met:

 It has the intent to  It has demonstrated

refinance on a long-term basis. AND the ability to refinance.

The ability to refinance is an unconditional

right at the financial year-end granted by the
lender to defer settlement for at least twelve
months. And it can be demonstrated by an:
 existing refinancing agreement, or
 actual refinancing at the financial year-end

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Definitions per SFRS(I) 1-37

A contingent liability is:

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

A contingent asset is a possible asset that arises from past events and
whose existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events not wholly within the
control of the entity.
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Contingent Liabilities

The uncertainties relate to:

1. The existence of the obligation or
2. The probability/amount of outflow

A contingent liability
is recorded for (1) a possible obligation;
or (2) a present obligation with future
outflows that are not probable or
cannot be reliably measured.

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Contingencies

A contingent liability is never accrued, but is only disclosed in the

footnotes to the financial statements:
1. The reporting entity must:
• Describe the nature of the contingent liability, and
• Provide an estimate of the financial effect,
2. And if practicable
• Indicate the uncertainties relating to the amount and timing of
the outflows, and
• State the possibility of any reimbursement.
3. Note that the cause of the uncertainty must occur before the
financial statement date.

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Provisions

A provision is a liability as it has all the three characteristics

of a one.
(1) past obligating event has occurred
(2) present obligation that leads to a
(3) future outflow of benefits.

The only Different from a

uncertainties are: contingent liability
• Timing, and • No uncertainty in
• Amount of the the existence of the
future outflow of obligation
benefits • There is a probable
outflow

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Provisions

Provisions are not “off balance sheet”

They are recognized if the three conditions below are met

An entity has present It is probable that an outflow A reliable estimate can be

obligation that arises as a of resources will be required made of the amount of the
result of a past event the settle the obligation obligation

Present Can be either legal or contractual

Obligation Legal obligations arise from contracts or laws

Constructive obligations arise from “valid expectations” that arise

from an entity’s actions and representations (past practices,
published policies or sufficiently specific statement entity
indicated to other parties that it accepts responsibilities)

For a contractual or legal obligation to exist, an obligating event

must have occurred

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Provisions

Probable Probable” in SFRS(I) 1-37 means “more likely than not”

outflow
“More likely than not” is not explicitly defined, but..
May assume a lower probability threshold than what is
implied by the term “probable”.

Reliable “Best estimate of the expenditure to settle the present

estimate obligation at the end of the reporting period.”
Which is the also the “amount that an entity would rationally
pay to settle or transfer”
An exception to this test is deemed to be extremely rare
Discounting required if the time value is material
An Expected Value Approach may be used when there is (1) a
large population of items or, (2) a large number of possible
outcomes.
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Product Warranties

• Product warranties inevitably entail costs.

• Like other provisions, the amount of those costs can be
reasonably estimated using commonly available estimation
techniques.
• The estimate requires the following entry:

GENERAL JOURNAL
Page: 15
Date Description Debit Credit
Warranty Expense $$$
Estimated Warranty Liability $$$

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 Provision for Restructuring
❖ A restructuring is a programme that is 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

❖ A constructive obligation to restructure arises only when an entity:

a) has a detailed formal plan for the restructuring identifying at least:
i) the business or part of a business concerned;
ii) the principal locations affected;
iii) the location, function, and approximate number of employees who will be
compensated for terminating their services;
iv) the expenditures that will be undertaken; and
v) when the plan will be implemented; and
b) has raised a valid expectation in those affected that it will carry out the restructuring
by
i) starting to implement that plan or When shall
provision be
ii) announcing its main features to those affected by it.
recognised?
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 Provision for Restructuring
➢ No obligation arises for the sale of an operation until the entity is
committed to the sale, i.e. there is a binding sale agreement.

➢ A restructuring provision shall include only the direct expenditures

arising from the restructuring, which are those that are both:
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;
b) marketing; or
c) investment in new systems and distribution networks.

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Onerous Contracts

An onerous contract is one in which:

“the unavoidable costs of meeting the obligations under the contract
exceed the economic benefits expected to be received under it.“

Unavoidable cost =
The “Unavoidable cost” is the
The lower of the cost fulfilling of fulfill a least net cost of exiting from
contract, and any compensation or penalties the contract
arising from failure to fulfill it.”

When a An impairment loss on assets Then, the present obligations

contract dedicated to that contract under the contract should be
becomes should be recognized under recognized and measured as a
onerous: SFRS(I) 1-36 provision

NOTE: Recognize a
Normally “off liability under
Executory balance sheet” SFRS(I) 1-37 when
Contracts onerous

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Litigation Claims

• The majority of medium and large-

size corporations annually report
contingent liabilities due to
litigation.

• The most common disclosure is a

note to the financial statements.

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Subsequent Events

When the cause of a loss contingency occurs before the year-end,

an adjusting event before financial statements are issued can
be used to determine how the contingency is reported.

If an event Occur in the period between the end of a

giving rise to a company’s financial year and the financial
loss contingency Adjusting statements authorization date
occurs after the Events
Provide evidence of conditions that existed
year-end, a at the end of the reporting period
liability should
not be accrued.
Instead, a
disclosure note
should be made

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Example
A Co. is in the oil industry and causes contamination, and it operates in a country
where there is no environmental legislation. However, A Co. has a widely published
environmental policy in which it undertakes to clean up all contamination that it
causes. It has a record of honouring this published policy.

Required:
Should A Co. recognise any provisions or disclose any contingencies for the current
period?

• Present obligation as a result of a past obligating event — The obligating

event is the contamination of the land, which gives rise to a constructive
obligation because the conduct of the entity has created a valid
expectation on the part of those affected by it that the entity will clean up
contamination.
• An outflow of resources embodying economic benefits in settlement —
Probable.
• Conclusion — Company X should recognise a provision for the best
estimate of the costs of clean-up. 37
Contingent Assets

Note that we have to record liabilities even

if the likelihood is “probable” and not
certain.

As a general principle, we
never record contingent
assets.

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 Contingent Assets

• Contingent assets usually arise from unplanned or other unexpected events

that give rise to the possibility of an inflow of economic benefits to the entity.
An example is a claim that an entity is pursuing through legal processes,
where the outcome is uncertain.

• Contingent assets are not recognised in financial statements since this may
result in the recognition of income that may never be realised. However,
when the realisation of income is virtually certain, then the related asset is
not a contingent asset and its recognition is appropriate.

• A contingent asset is disclosed, where an inflow of economic benefits is

probable.

• Contingent assets are assessed continually to ensure that developments are

appropriately reflected in the financial statements. If it has become virtually
certain that an inflow of economic benefits will arise, the asset and the
related income are recognised in the financial 39
Summary per SFRS(I) 1-37 IG
Decision Tree for Provisions and
Contingent Liabilities:

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Summary per SFRS(I) 1-37 IG

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Summary per SFRS(I) 1-37 IG

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Disclosure (Provision)
For each class of provision, an entity shall disclose:

(a) the carrying amount at the beginning and end of the period;
(b) additional provisions made in the period, including increases to existing provisions;
(c) amounts used (ie incurred and charged against the provision) during the period;
(d) unused amounts reversed during the period; and
(e) the increase during the period in the discounted amount arising from the passage
of time and the effect of any change in the discount rate.

Comparative information is not required.

An entity shall disclose the following for each class of provision:

(a) a brief description of the nature of the obligation and the expected timing of any
resulting outflows of economic benefits;
(b) an indication of the uncertainties about the amount or timing of those outflows.
Where necessary to provide adequate information, an entity shall disclose the major
assumptions made concerning future events; and
(c) the amount of any expected reimbursement, stating the amount of any asset that
has been recognised for that expected reimbursement. 43
Disclosure (Contingencies)
Unless the possibility of any outflow in settlement is remote, an entity shall disclose
for each class of contingent liability at the end of the reporting period a brief
description of the nature of the contingent liability and, where practicable:
(a) an estimate of its financial effect;
(b) an indication of the uncertainties relating to the amount or timing of any outflow;
and
(c) the possibility of any reimbursement.

Where an inflow of economic benefits is probable, an entity shall disclose a brief

description of the nature of the contingent assets at the end of the reporting period,
and, where practicable, an estimate of their financial effect.

In extremely rare cases, disclosure of some or all of the information can be expected
to prejudice seriously the position of the entity in a dispute with other parties on the
subject matter of the provision, contingent liability or contingent asset. In such cases,
an entity need not disclose the information, but shall disclose the general nature of
the dispute, together with the fact that, and reason why, the information has not
been disclosed.

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