FR - IAS 37 (Provisons)

TY is the main contractor employing sub-contractors to assist it when required.

TY has recently completed a contract replacing a roof on the local school. Despite this, the roof has been leaking and some sections are now unsafe. The school is suing TY for $20,000 to repair the roof.

TY used a sub-contractor to install the roof and regards the sub-contractor’s work as faulty. TY has raised a court action against the sub-contractor claiming the cost of the school’s action plus legal fees, a total of $22,000.

TY has been informed by legal advisers that it will probably lose the case brought against it by the school and will probably win the case against the sub-contractor.

How should these events be accounted for in TY’s financial statements?

• 1. Provide for the $20,000 liability and disregard the case against the sub-contractor

• 1. Provide for the $20,000 liability and disclose the probable receipt of cash from the case against the sub-contractor in a note

• 1. Make no provision but disclose the $20,000 liability in a note

• 1. Provide for the $20,000 liability and recognise the probable receipt of cash from the case against the sub-contractor in a current asset

MN obtained a government licence to operate a mine from 1 April 20X1. The licence requires that at the end of the mine’s useful life, all buildings must be removed from the site and the site landscaped. MN estimates that the cost of this decommissioning work will be $1,000,000 in 10 years’ time using a discount factor of 8%. A 10-year discount factor at 8% is 0.463.

According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets what is the provision which MN should recognise in its statement of financial position as at 31 March 20X2?

• 1. $100,000

• 1. $463,000

• 1. $500,000

• 1. $1,000,000

The directors of Wings Co have received legal advice that the most likely outcome of a lawsuit brought by a customer is that there is a 75% chance that the company will lose the case and have to pay $50,000, a 15% chance of having to pay $70,000 and a 10% chance of paying nothing.

What is the best estimate of a provision for the outcome of the lawsuit?

• 1. $37,500

• 1. $48,000

• 1. $50,000

• 1. $70,000

Fastforce sells a product line with a 12-month warranty. Any defect arising during the warranty period is repaired free of charge. Items which cannot be repaired are replaced. Repairs cost $20, replacements cost $70. Based on past experience, 6% of items sold will be returned and repaired and 2% will be replaced.

At 1 January 20X4, the warranty provision was $24,800. During the year to 31 December 20X4, Fastforce sold 8,550 items and incurred $26,100 in repairing and replacing returns under warranty.

For the year ended 31 December 20X4, how much should be expensed in the statement of profit or loss in respect of the product warranty?

• 1. $22,230

• 1. $23,530

• 1. $24,800

• 1. $26,100

Caldwell is restructuring its operations and closing one of its divisions.

Which of the following costs cannot be included in the restructuring provision?

• 1. Costs of exiting a supply contract that is onerous due to the restructuring

• 1. Redundancy payments to employees whose contracts are terminated

• 1. Legal costs in connection with the restructuring

• 1. Training costs for staff being redeployed elsewhere

The following items have arisen during the preparation of Borough Co’s draft financial statements for the year ended 30 September 20X6:

1. 1. On 1 October 20X5, Borough Co commenced the extraction of crude oil from a new well on the seabed. The cost of a 10-year licence to extract the oil was $50m. At the end of the extraction, sustainability legislation requires that Borough Co makes good the damage the extraction has caused to the seabed. The cost of this will be a fixed amount of $20m and a variable amount of $0.02 per barrel extracted. Both amounts are present values as at 1 October 20X5 (discounted at 8%) of the estimated costs in 10 years’ time. In the year to 30 September 20X6 Borough Co extracted 150 million barrels of oil.

2. 2. Borough Co owns the whole of the equity share capital of its subsidiary Hamlet. Hamlet’s statement of financial position includes a loan of $25m that is repayable in five years’ time. $15m of this loan is secured on Hamlet’s property and the remaining $10m is guaranteed by Borough Co in the event of a default by Hamlet. The current fair value of its property is estimated at $12m and there are concerns over whether Hamlet can survive the recession and therefore repay the loan.

What is the carrying amount of the environmental provision in the statement of financial position as at 30 September 20X6?

• 1. $24.84m

• 1. $20.03m

• 1. $23.01m

• 1. $21.60m

The following items have arisen during the preparation of Borough Co’s draft financial statements for the year ended 30 September 20X6:

1. 1. On 1 October 20X5, Borough Co commenced the extraction of crude oil from a new well on the seabed. The cost of a 10-year licence to extract the oil was $50m. At the end of the extraction, sustainability legislation requires that Borough Co makes good the damage the extraction has caused to the seabed. The cost of this will be a fixed amount of $20m and a variable amount of $0.02 per barrel extracted. Both amounts are present values as at 1 October 20X5 (discounted at 8%) of the estimated costs in 10 years’ time. In the year to 30 September 20X6 Borough Co extracted 150 million barrels of oil.

2. 2. Borough Co owns the whole of the equity share capital of its subsidiary Hamlet. Hamlet’s statement of financial position includes a loan of $25m that is repayable in five years’ time. $15m of this loan is secured on Hamlet’s property and the remaining $10m is guaranteed by Borough Co in the event of a default by Hamlet. The current fair value of its property is estimated at $12m and there are concerns over whether Hamlet can survive the recession and therefore repay the loan.

4. Which TWO of the following would require a provision to be recognised by Borough Co as at 30 September 20X6?

• 1. New data protection laws come into force on 1 December 20X6 that will require a large number of staff to be retrained. The training costs have not yet been finalised

• 1. Borough Co is negotiating with its insurance provider about the amount of an insurance claim. On 20 October 20X6, the insurance provider agreed to pay $200,000

• 1. Borough Co makes refunds to customers for any goods returned within 30 days of sale, and has done so for many years

• 1. A customer is suing Borough Co for damages. Borough Co is contesting the claim but legal advisers consider that Borough Co is likely to lose the case

The following items have arisen during the preparation of Borough Co’s draft financial statements for the year ended 30 September 20X6:

1. 1. On 1 October 20X5, Borough Co commenced the extraction of crude oil from a new well on the seabed. The cost of a 10-year licence to extract the oil was $50m. At the end of the extraction, sustainability legislation requires that Borough Co makes good the damage the extraction has caused to the seabed. The cost of this will be a fixed amount of $20m and a variable amount of $0.02 per barrel extracted. Both amounts are present values as at 1 October 20X5 (discounted at 8%) of the estimated costs in 10 years’ time. In the year to 30 September 20X6 Borough Co extracted 150 million barrels of oil.

2. 2. Borough Co owns the whole of the equity share capital of its subsidiary Hamlet. Hamlet’s statement of financial position includes a loan of $25m that is repayable in five years’ time. $15m of this loan is secured on Hamlet’s property and the remaining $10m is guaranteed by Borough Co in the event of a default by Hamlet. The current fair value of its property is estimated at $12m and there are concerns over whether Hamlet can survive the recession and therefore repay the loan.

3. Borough Co entered into a “take or pay” contract to purchase goods for $400 or pay $50 not to take the goods. The fair value of the goods has now fallen to $320 and the contract has become onerous.

4. How should an onerous contract be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets?

• 1. Recognise all future payments as a liability immediately

• 1. Account for any costs associated with the contract only when and as they fall due

• 1. Recognise the least net cost option of exiting the contract

• 1. Disclose the full costs associated with the rental contract as a note to the financial statements

Radar Co is preparing its financial statements for the year ended 31 March 20X6.

Factory closure

At a board meeting on 1 July 20X5, Radar Co’s directors made the decision to close down one of its factories on 31 March 20X6. The factory and its related plant would then be sold.

On 1 January 20X6, a formal plan was formulated and the factory’s 250 employees were given three months’ notice of redundancy. Customers and suppliers were also informed of the closure at this date.

The directors of Radar Co have provided the following information:

• - Fifty of the employees would be retrained and deployed to other subsidiaries within the group at a cost of $125,000; the remainder will accept redundancy and be paid an average of $5,000 each.

• - The factory is expected to sell for a profit of $1.2m.

• - Factory plant has a carrying amount of $2.2m, but is only expected to sell for $500,000 incurring $50,000 of selling costs.

• What provision should Radar Co recognise in its statement of financial position as at 31 March 20X6 in respect of the redundancy?

• 1. $1,250,000

• 1. $0

• 1. $1,125,000

• 1. $1,000,000

Radar Co is preparing its financial statements for the year ended 31 March 20X6.

Factory closure

At a board meeting on 1 July 20X5, Radar Co’s directors made the decision to close down one of its factories on 31 March 20X6. The factory and its related plant would then be sold.

On 1 January 20X6, a formal plan was formulated and the factory’s 250 employees were given three months’ notice of redundancy. Customers and suppliers were also informed of the closure at this date.

The directors of Radar Co have provided the following information:

• - Fifty of the employees would be retrained and deployed to other subsidiaries within the group at a cost of $125,000; the remainder will accept redundancy and be paid an average of $5,000 each.

• - The factory is expected to sell for a profit of $1.2m.

• - Factory plant has a carrying amount of $2.2m, but is only expected to sell for $500,000 incurring $50,000 of selling costs.

• What loss should be recognised in Radar Co’s statement of profit or loss for the year ended 31 March 20X6 in respect of the plant?

• 1. $500,000

• 1. $1,750,000

• 1. $1,700,000

• 1. $550,000