Nội dung

Revise lecture 17 1 Measuring provisions The amount recognised as a provision should be: • A realistic-estimate • A prudent estimate of the expenditure needed to settle the obligation existing at the reporting date • Discounted whenever the effect of this is material 2 Methods of measuring uncertainties Methods of measuring uncertainties include: • Weighting the cost of all probable outcomes according to their probabilities (expected values) • Considering a range of possible outcomes 3 Warranty provisions Introduction A warranty is often given in manufacturing and retailing businesses. It is either an: 1. Express (legal) or 2. Implied (constructive) Obligation to make good or replace faulty products. 4 Warranty provisions A provision is required at the time of the sale rather than the time of the repair/replacement as the making of the sale is the past event which gives rise to an obligation. 5 Warranty provisions This requires the seller to analyse past experience so that they can estimate: • How many claims will be made. If manufacturing techniques improve, there may be fewer claims in the future than there have been in the past. • How much each repair will cost. As technology becomes more complex, each repair may cost more. 6 Warranty provisions The provision set up at the time of sale: • Is the number of repairs expected in the future times at the expected cost of each repair. • Should be reviewed at the end of each accounting period in the light of further experience. 7 Guarantees • In some instances (particularly in groups) one company will make a guarantee to another to pay off a loan, etc. if the other company is unable to do so. • This guarantee should be provided for if it is probable that the payment will have to be made. • It may otherwise require disclosure as a contingent liability. 8 Future operating losses • No provision may be made for future operating losses because they arise in the future and therefore do not meet the criterion of a liability. 9 Onerous contracts • An onerous contracts 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. 10 Onerous leases • An onerous lease is an onerous contract, i.e. one where the unavoidable costs under the lease exceed the economic benefits expected to be gained from it. • If leased premises have become surplus to requirements but the lessee cannot find anyone to sublet the premises to, the lessee will still have to make the regular lease payments, without being able to use the premises. 11 Onerous leases • The signing of the lease is the past event giving rise to the obligation to make the lease payments. • A payment for this payment should be recognised as an expense in the income statement in the period when the lease becomes onerous. 12 Question 1 – Onerous contracts A company has 10 years left to run on the lease of a property that is currently unoccupied. The present value of the future rentals at the reporting date is Rs50,000. Subletting possibilities are limited but the directors feel that likely future subletting rental could have a present value of Rs10,000. • What is the accounting treatment? 13 Question 1 - Answer • A provision of Rs 50,000 would be required in respect of this onerous contract. The Rs10,000 should be: 1. Disclosed if possible 2. Booked as an asset if virtually certain 14 Environmental provisions • A provision will be made for future environmental costs if there is either a legal or co constructive obligation to carry out the work. • This will be discounted to present value at a pre-tax market rate. 15 Restructuring provisions A restructuring is a programme that is planned and controlled by management and materially changes either: • The scope of a business undertaken by an entity, or • The manner in which that business is conducted. 16 Restructuring provisions A provision may only be made if: • A detailed, formal and approved plan exists • The plan has been announced to those affected The provision should: • Include direct expenditure arising from restructuring • Exclude costs associated with ongoing activities 17 Restructuring provisions • In the context of a restructuring, a detalied, formal and approved plan must exist, but this is not enough, because management may change its mind. • A provision should only be made if the plan has also been announced to those affected. This creates a constructive obligation, because management is now very unlikely to change its mind. 18 Question 2 – Restructuring provisions On 14th June 2005 a decision was made by the board of an entity to close down a division. The decision was not communicated at that time to any of those affected and no other steps were taken to implement the decision by the year end of 30th June 2005. the division was closed in September 2005. • Should a provision be made at 30th June 2005 for the cost of closing down the division? 19 Question 2 – Answer • No constructive obligation exists. • This is a board decision, which can be reversed. • No provision can be made 20 Question 2 – Restructuring provisions On 14 June 2005 a decision was made by the board of an entity to close down a division. On 28 June 2005 a detailed plan for closing down the division was agreed by the board. Redundancy notices were also sent out to the staff of the affected division. The division was closed in September 2005. • Should a provision be made at 30th June 2005 for the cost of closing down the division? 21 Question 2 - Answer • The detailed plan and the redundancy notices create a valid expectation and therefore a constructive obligation. • Yes, a provision is required. 22