Provisions 1

Exercise 14

Provisions

Multiple Select

1. An entity recognizes a provision only when: (answers are more than 1)

• The entity has a present obligation as a result of a past event.

• It is probable (more likely than not that the entity will be required to transfer economic benefits in its settlement.

• The amount of obligation can be estimated reliably.

All of the choices

Criteria for recognition.

Multiple Choice

An entity has made a written pledge to contribute a sum of money toward the construction of the new performing arts theatre in its community. The executives of the entity appeared in a press conference to announce the pledge. With the entity’s consent, the charitable organization that is building the arts theatre cited the entity’s pledge in its materials soliciting additional pledges for construction. Under the local law, pledges to charitable organizations are legally enforceable. Should a provision be recognized?

• a. No provision is to be recognized since there is no action filed in court to enforce the obligation.

• b. Provision shall be recognized since a written pledge is already made by the entity and therefore binding between them.

• c. Provision shall be recognized since the pledge made by the entity not only created a constructive obligation but also legal as breach thereof can be enforced through court action.

C

Provision shall be recognized. The pledge made by the entity is a present obligation that is not only a constructive but legal obligation. It is probable that an outflow of or payment of the contribution will be required to settle the obligation since a reliable estimate can be made from the written pledge.

Multiple Choice

A case is filed by B for recovery of damages against Agency A, a government owned hospital for a blood contamination that occurred in the hospital. The Chief Legal Counsel of the agency estimates based on experience that at the reporting date the entity has a 60% chance of being ordered to pay B damages of P100, 000. Is there a provision to be recognized?

• a. A provision is to be recognized in the amount of P100,000 since it is more likely than not that Agency A will be ordered by the court to pay B for the damages.

• b. No provision is to be recognized since it is only 60% and not 100% chance of being ordered by the court to pay B damages.

• c. No provision is to be recognized since a decision is not yet promulgated by the court.

A

A provision should be recognized since there is probability of more than 50 % that the entity will pay the plaintiff for the damages and lose the case.

Multiple Choice

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 6 months after the purchase. Based on their past data, repair costs for minor and major defects are usually detected in products sold amounting to P1,000,000.00 and P5,000,000, respectively. The entity’s past experience and future expectations indicate that 75% of the goods will have no defects, 20% will have minor defects and 5% will have major defects. How much provision is to be recorded by the entity?

• P250,000

• P200,000

• P450,000

P450,000

At the outset, it is clear that the entity sells goods with a warranty under-which customers are covered for the cost of repairs of any manufacturing defects that become apparent within 6 months after the purchase. The cost of repairs to be recognized as provision shall be computed as follows:

75% sales                                                  none

20% sales  (20% x 1,000,000) =            200,000.00         

5% sales   (5%  x 5,000,000)     =          250,000.00

Total expected value of repairs           450,000.00

Multiple Choice

An oil entity is exploring oil off the shores of the Philippine Deep. The entity has employed all exploration experts from around the globe. Despite all efforts, a major oil spill occurred and grabbed the attention of the media. The legal counsel of the entity has advised that there is no law that would require the entity to pay for the oil spill. However, in its TV ad and promotional brochures, the entity has clearly stated that it is very conscious of its responsibilities toward the environment and make good for any losses resulting from its oil exploration activities. The policy has been widely published. As a matter of fact, the chief executive officer of the entity acknowledged this policy in press conference when media practitioners raised questions on the issue of oil spill. The best estimate for the cost to clean up the major oil spill amounts to P 250,000.00. How much provision is to be recorded by the entity?

• P0

• P250,000

• P100,000

P250,000

There is a need to recognize a provision for major oil spill since a constructive obligation is created when the entity advertised and made public pronouncements on policy regarding oil spill thus creating an expectation in the minds of the public that the entity will honor any obligations that may arise later from its oil explorations activities.

Multiple Choice

C has initiated a lawsuit against Agency A for recovery of damages when accidentally one of the vehicles owned by the agency collided with the car then driven by C. The Chief Legal Counsel of the Agency estimates from experience that at December 2015, the entity has a 60% chance of winning the lawsuit and thereby avoiding the payment of damages. Furthermore, the counsel estimates that the agency has 20% chance of being ordered to pay C damages of P100,000 and a 20% chance of being ordered to pay C damages of P10,000. Do we need to recognize and present this as a provision?

• Yes

• No

No

The agency has a contingent liability not a provision. The contingent liability is not recognized in the agency’s financial statement of financial position because it is not probable that an outflow of economic benefits is required to settle the obligation and/or the amount cannot be measured reliably. 

Multiple Choice

Use the facts given before, but this time assumes that on December 31, 2015, the Chief Legal Counsel of Agency A estimates from past experience that the possibility of losing the case filed by C is remote. what should the accountant do to its books?

• Recognize a contingent liability

• Recognize a contingent asset

• Recognize a provision

• Do nothing

Do nothing.

Since the possibility of any outflow/payment of damages in settlement is remote, the agency is not required to disclose.

Multiple Choice

On March 2015, Agency A is taking legal action against its competitor for patent infringement relating to a patent that had been granted to the agency on one of its products. The outcome of the case is uncertain. However, it is probable that the court will order the competitor to pay damages to the entity.

• Recognize the contingent asset as part of non- current assets in the financial statements

• Recognize the asset as a receivable

• Disclose the contingent asset

Disclose the contingent asset

The agency must disclose a brief description of the nature of the contingent asset because an inflow of economic benefits is probable. When practicable, an estimate of their financial effect must also be disclosed. 

Multiple Choice

Use facts given before, but assumes that on June 2015 the Chief Legal Counsel of Agency A informs the management that it is now virtually certain that the court will order the competitor to pay damages to the entity.

• Record or make an entry to recognize Other Receivable account.

• Disclose the contingent asset

Record or make an entry to recognize Other Receivable account.

The agency must recognise an asset. It is no longer a contingent asset because the virtual certainty of receiving benefits removes the contingency.

Multiple Choice

Continuation of facts given on the previous question, this time assumes only that on July 2015 the management learns that it becomes probable that the court will rule in favor of the competitor. What should the accountant do?

• Make adjustments

• No adjustments

No adjustments

An asset must not be recognised nor disclosed since inflow of economic benefits is not probable on the contrary outflow of economic benefits becomes probable. 

Multiple Choice

1. An entity has made a written pledge to contribute a sum of money toward the construction of the new performing arts theatre in its community. The executives of the entity appeared in a press conference to announce the pledge. With the entity’s consent, the charitable organization that is building the arts theatre cited the entity’s pledge in its materials soliciting additional pledges for construction. Under the local law, pledges to charitable organizations are legally enforceable. Is a provision be recognized?

• a. No provision is to be recognized since there is no action filed in court to enforce the obligation.

• b. Provision shall be recognized since a written pledge is already made by the entity and therefore binding between them.

• c. Provision shall be recognized since the pledge made by the entity not only created a constructive obligation but also legal as breach thereof can be enforced through court action.