ABC Limited manufactures and sells high-end fashion products

HKAS 37 Provision, Contingent Liabilities and Contingent Asset Provision 1. Definitions Provision is a liability of uncertain timing and amount Liability is a present obligation of the entity arising from past event, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits 2. Provision VS Other Liabilities and Accruals Main difference : Uncertain about timing or amount of future expenditure 3. Recognition of Provision :KAS 37: A provision shall be r ecognized when: (a) An entity has a present obligation (legal or constructive) as a result of a past event (b) =t is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; AND (c) A reliable estimate can be made of the amount of the obligation =f ALL these conditions are NOT met, NO PROVISION recognized I. Present Obligation – Can be Legal or Constructive – Legal obligation : a duty to act in a certain way deriving from a contract, legislation, or some othe r operation of the law – Constructive obligation An obligation that derives from an entity’s actions where: ~ By an established pattern of past practice , published policies or a sufficiently specific current statement , the entity has indicated to other parties that it will accept certain responsibilities ; AND ~ As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. ** Court Case is Underway  Not clear whether there is present obligation  All available evidence should be considered to see whether there exists present obligation as a result of past event II. Probable Transfer of Economic Benefit – “Probable ”: Probability that the event will occur is greater than the probability that it will not (>50% ) 4. Measurement The amount recogni zed as a provision sh all be the best estimate of the expenditure required to settle the present obligation at the year end Best Estimate – Determined by the judgment of the management of the entity, supplemented by experience of similar transactions and reports from independent experts – Expected Values  Used when the provision being measured involved a large population of items Other Considerations in measuring provision – Risks and Uncertainties – Present Value – Future Events – Expected Disposal of Assets 5. Reimbursement – Some or all of the expenditure needed to settle a provision may be expected to be recovered from a third party through insurance contracts, indemnity clauses or supplier ’s warranties. – reimbursement shall be recogni zed when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation – the reimbursemen t shall be treated as separate asset – the amount recognized for reimbursement shall not exceed the amount of provision – P/L – expense relating to provision may be presented the net amount recognized for reimbursement – General Accounting Treatment Recognize Pr ovision -> Reimbursement should be treated as a separate asset -> P/L: Present as net amount 6. Change in Provision – Provision should be reviewed at each reporting date and adjusted to reflect best estimates – No longer probable transfer economic benefits  Reverse Provision 7. Application of the Recognition and Measurement Rule I. Future Operating Losses – NO PROVISION recognized (No present obligation) – Cannot meet definition of liability and general recognition criteria for provision – Hust an indication of impairmen t II. Onerous Contract – 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 . The unavoidable costs under a contract reflect the least net c ost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it. – Present obligation under the contract shall be recognized + Probable outflow + Amount uncertain – Measured as Provision A common example would be leasehold property which is vacated before the lease term ends. For the remaining years of the lease, the cost of the property (future lease payments) exceeds the benefits derived from the property (likely to amount to nil if it is to be left vacant). =n this case, provision should be made for the future unavoidable lease payments as at the date on which the property is vacated. The provision is released as these payments are made in future years. III. Restructuring – A pr ogram 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. – E.g sale and termination of line of business, closure of business locations, changes in management structure, fundamental reorganization – Whether or not an entity has obligation at year end – A constructive obligation to restructure arises only when  The entity has a detailed formal plan for restructuring identifying  The business or part of business concerned  The principal location affected  Location, function and approximate number of employees who will be compensated for terminating their services  The expenditure that will be undertaken  When the plan is implemented; AND  The entity 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 affecte d by it – Restructuring provision should include only the direct expenditures arising from the restructuring that are both:  Necessarily entailed by the restructuring  Not associated with the ongoing activities of the entity – BUT NOT =NCLUDE  Retraining or relocating continuing staff  Marketing  =nvestment in new systems and distribution networks  Future operating losses  Losses or gains on the expected disposal of assets Contingent Liability 1. A contingent liability is – 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 entity’s control ; OR – A present obligation that arises from past events but is not reco gni zed because:  =t is not probable that a transfer of economic benefits will be required to settle the obligation  Amount cannot be measured with sufficient reliability 2. Accounting Treatment Disclose in F.S Contingent Asset 1. Contingent asset is a possible as set that arises from past events and whose existence will be confirmed by the occurrence of one or more uncertain future events not wholly within the entity’s control. 2. Accounting Treatment Disclose in F.S Only when realization of related economic benefits is virtually certain -> Recognize as asset (A/R)

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