Objective, Scope & Definitions
1. What is the key difference between a provision and other liabilities?
(a) Provisions require an invoice.
(b) Provisions have uncertain timing/amount.
(c) Provisions and trade payables are identical.
(d) Accruals and provisions are the same.
(b) Provisions have uncertain timing/amount.
1. Under IAS 37, when is a contingent liability disclosed instead of a provision? Choose the best option:
(a) When the outflow of resources is remote but the amount cannot be estimated.
(b) When recording a provision affects the profitability of the company.
(c) When the outflow of resources is probable and can be measured reliably.
(d) When the outflow of economic resources is possible but not probable.
(d) When the outflow of economic resources is possible but not probable.
IAS 37. 10 says that "A contingent liability is a present obligation that arises from past events but is not recognized because: it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation."
1. If a third party is responsible for a liability and the entity has no obligation to pay if the third party fails, what should the entity do?
(a) Recognize a provision and a reimbursement asset.
(b) Recognize only a reimbursement asset.
(c) Do not recognize a provision or reimbursement asset.
(d) Disclose the obligation as a contingent liability.
(c) If the entity is not liable for the costs if the third party does not pay, no provision or reimbursement asset is recognized.
1. XYZ company projected $200 million loss due to decline in consumer demand in next year. Choose best option.
(a) Recognize a provision a provision of $200 million for the expected loss.
(b) Do not recognize provision at all.
(c) Recognize provision of $100 million.
(b) Do not recognize provision at all.
Since it’s a future operating loss.
1. Best AC’s Ltd was sued by a customer for $90,000, who claimed that their product was defected and have resulted in breathing issues to his son who had medical issues. Best AC’s Ltd. is famous for its best quality products and has always passed all the inspections required to sell AC’s. The case just went to court and no outcome has been predicted yet. How should it be treated?
(a) Record $90,000 as provision.
(b) Disclose this in the notes as Contingent Liability.
(c) Don’t disclose it as judge has not made any judgement yet.
(d) Record contingent liability for the $90,000.
(c) Don’t disclose it as judge has not made any judgement yet.
2. What defines an obligating event?
(a) Event that creates a legal or constructive obligation.
(b) Any financial transaction of an entity.
(c) A contract that may or may not require settlement.
(d) Voluntary decision by management.
(a) Event that creates a legal or constructive obligation.
2. For which of the following circumstances is a provision not recognized?
(a) Major overhaul or repairs
(b) Warranties
(c) Decommissioning costs
(d) Refunds
(a) Major overhaul or repairs
Overhaul or repairs are related to future actions, not a past obligating event.
Note: Provision is made for refunds only when there is a policy (i.e., a constructive obligation) in the company's sale contracts that it will provide refunds.
A company has recognized a provision of $1,000,000 for future environmental cleanup costs, which will be paid in 5 years. The present value of the provision is $747,000 at a discount rate of 6%. How should the company account for this provision next year?
(a) Keep the provision amount unchanged.
(b) Increase the provision amount to reflect the passage of time and recognize an interest expense.
(c) Reduce the provision amount as time passes.
(d) Reverse the provision since the payment is not due yet.
(b) The provision must increase over time as the liability approaches settlement, and the increase is recorded as interest expense
On January 1, 2025 XYZ company entered into a contract with ABC company to provide 100 units of computers for $500,000 by March 30, 2025. However, on March 15, 2025 XYZ predicted loss of $100,000 from this deal due to launch of new technology. Contract was not binding.
(a) Recognize a provision for $500,000 on XYZ balance sheet.
(b) Recognize a provision for $100,000 on XYZ balance sheet.
(c) Do not recognize provision at all.
(c) Do not recognize provision at all.
Contract was not binding hence no unavoidable cost.
2. Best AC Ltd lost the lawsuit, and judge asked them to pay the customer $50,000. How should this be treated now?
(a) Record $90,000 as provision.
(b) Record it as contingent liability.
(c) Record $50,000 as provision.
(d) Don’t record it.
(c) Record $50,000 as provision.
3. Which of the following is a contingent liability?
(a) Loan that is due next month.
(b) A possible obligation dependent on future events.
(c) A liability with a certain amount and timing.
(d) A trade payable that has been invoiced.
(b) A possible obligation dependent on future events.
3. Which of the following is correct about contingent assets? Choose the best option:
(a) If the inflow of resources becomes virtually certain, a contingent asset is disclosed.
(b) A contingent asset is recognized if the inflow of resources is probable.
(c) When the inflow of resources is lower than remote, a contingent asset is reported in disclosures.
(d) A disclosure for a contingent asset is made when the inflow of resources is more than likely.
(d) A disclosure for a contingent asset is made when the inflow of resources is more than likely.
IAS 37.34 states that "A contingent asset is disclosed, as required by paragraph 89, where an inflow of economic benefits is probable."
3. A company has a provision of $1 million for future legal expenses. Can it use this provision to pay employee severance costs?
(a) Yes, if the company has no other funds available.
(b) No, because provisions must only be used for their original purpose.
(c) Yes, if the costs are similar in nature.
(d) No, unless the provision is more than five years old.
(b) No, because provisions must only be used for their original purpose.
IAS 37.61 states that provisions must only be used for the original purpose they were created for.
3. XYZ company is relocating business to new city, they have created a formal relocation plan which approved by management of XYZ and also formally communicated. XYZ expected $100,000 severance pay cost, $300,000 dismantling cost, $50,000 training cost of staff at new location and $100,000 marketing cost.
(a) XYZ should recognize a provision for $400,000.
(b) XYZ should recognize a provision for $550,000.
(c) XYZ should recognize a provision for $150,000.
(a) XYZ should recognize a provision for $400,000.
Training costs, and marketing costs are not included in restructuring provision as per IAS 37.
3. How should classes of provision be disclosed?
(a) Record balance at Dec 31 and then carry it forward in the next years.
(b) Account for only additions made in the year.
(c) Account for additions made in the provisions along with any amounts used or unused amount reversed and then determine the ending balance.
(d) Don’t account for anything except beginning and ending balance.
(c) Account for additions made in the provisions along with any amounts used or unused amount reversed and then determine the ending balance.
1. RGP Enterprises launched a new product, but due to a breach of confidentiality, a customer sued the company for $90,000 in damages. The company’s legal advisor estimates that there is a 25% probability of winning the case.
As an accountant, figure out:
Whether a provision should be recognized ?
How to recognize and measure the provision?
What will be the journal entry?
The provision should be recognized and measured.
The probability to lose if >50%.
The estimated cost: 75%×$90,000 = $67,500
The 25% chance of winning is a contingent asset and should only be disclosed, not recognized.
Journal Entry
Dr. Legal Expense $67,500
Cr. Provision for Lawsuit $67,500