PAS 37 – PROVISIONS, CONTINGENT LIABILITIES, AND CONTINGENT ASSETS

Intermediate Accounting 2 (Millan)

PAS 37 – prescribes the accounting and disclosure requirements for provisions, contingent liabilities,
and contingent assets to help users understand their nature, timing, and amount.

– applies to the accounting for provisions, contingent liabilities, and contingent assets,
EXCEPT those arising from 1executory contracts (unless they are onerous), and 2those that are
covered by other PFRSs.

Executory contracts – are contracts that are not yet fully executed, meaning, the parties thereto still
have obligations to perform.

Onerous contracts – are contracts wherein the cost of fulfilling it exceeds the economic benefits
expected to be derived from it; burdensome.

PROVISIONS

o A liability of uncertain timing or amount.

o Differs from other liabilities because of the uncertainty in the timing of their settlement or
the amount needed to settle them.
o Must be necessarily estimated.
o Presented in the statement of financial position separately from other types of liabilities.

EXAMPLES OF PROVISIONS

 Warranty obligations
 Estimated liabilities on pending lawsuits
 Provisions for environmental damages
 Provisions of decommissioning costs of an item of PPE
 Obligations caused by an entity’s policy to make refunds to customers
 Obligations arising from guarantees
 Provisions on onerous contracts (e.g., purchase commitments)
 Provisions for restructuring costs

RECOGNITION OF PROVISIONS

ALL of the following conditions must be met:

a.) The entity has a present obligation (legal or constructive) resulting from a past event;
b.) It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation;
c.) The amount of the obligation can be reliably estimated.

If any of the conditions is not met, NO provision is recognized

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

CONTINGENT LIABILITIES

o A possible obligation whose existence will be confirmed only by the occurrence or non-
occurrence of one or more uncertain future events not wholly within the control of the
entity.
o A present obligation but:
 It is not probable that it will cause an outflow in its settlement; or
 Its amount cannot be reliably estimated.
o It is only disclosed, EXCEPT when the possibility of an outflow of resources embodying
economic benefits is remote.

CONTINGENT ASSETS

o Those that are NOT recognized because they do NOT meet all of the asset recognition
criteria (i.e., ‘resource controlled arising from past events’, ‘probable inflow’, and ‘reliable
estimation’).
o It includes possible inflows of economic benefits from unplanned or unexpected events
(e.g. claims under tax disputes and disputed insurance claims)
o It is only disclosed, if the inflow of economic benefits is probable.
o They are NOT recognized as it may result to the recognition of income that may never be
realized.
o When the realization of income is virtually certain, the asset is NOT a contingent asset and
therefore, it is appropriate to recognize it.

TABULAR SUMMARY OF THE CONTENGENCIES

Type Probable Possible Remote

Contingency Recognize and Disclose ONLY Ignore
Liabilities Disclose
Contingency Assets Disclose ONLY Ignore Ignore

MEASUREMENT OF PROVISIONS

o Measured at the best estimate of the amount needed to settle them at the end of the
reporting period.
 Estimate requires management’s judgement, supplemented by experience from
similar transactions, and reports from independent experts.
o Measured at its expected value if it involves a large population of items.
 Expected value is computed by weighing all possible outcomes by their associated
probabilities.
o Measured at its mid-point if there is a continuous range of possible outcomes and each
point in that range is as likely as any other.

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

TABULAR SUMMARY OF THE MEASUREMENTS

NATURE OF THE OUTFLOW MEASUREMENT BASIS

General rule Best estimate
Involves a large population of items Expected value (Probability Weighted
Average)
Each possible outcome in a range is as likely as Mid-point
any other

RISK AND UNCERTAINTIES

o The estimates may be increased by a risk adjustment factor to provide an allowance for
imprecision inherent in estimates.
o This does not mean that the entity can make excessive provisions or can deliberately overstate
liabilities.

PRESENT VALUE

o If the effect of time value of money is material, the estimate of a provision is discounted to its
present value using a pre-tax discount rate.
o Usually the case for provisions for restoration and decommissioning costs.

FUTURE EVENTS

o Can affect the amount needed to settle an obligation.

o Considered in estimating a provision only if there is an objective evidence that supports their
anticipation.

REIMBURSEMENTS

o It is recognized if it is virtually certain that the reimbursement will be received.

o The reimbursement asset is presented separately in the statement of financial position from
the provision.
o The amount recognized for the reimbursement should NOT exceed the amount of the
provision.

RECORDING THE PROVISION

o Provisions are normally recognized as a debit to expense (or loss) and a credit to an estimated
liability account.
o Sometimes it forms part of the cost of an asset.

CHANGES IN PROVISIONS

o Reviewed at the end of each reporting period and adjusted to reflect the current best estimate.
o It is accounted for prospectively by:
 Accruing an additional amount
 Reversing a previously recognized amount
o If discounted, the amortization of the related discount is recognized as interest expense.\

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

USE OF PROVISIONS

o Used only for the expenditure it was originally intended for.

o Charging expenditure against a provision that is intended for another purpose is inappropriate.

APPLICATION OF THE RECOGNITION AND MEASUREMENT RULES

FUTURE OPERATING LOSSES

o No provision is recognized for future operating losses because they do NOT meet the liability
definition.
o The expectation of future operating losses may indicate that certain assets may be impaired.

ONEROUS CONTRACTS

o The provision recognized from an onerous contract reflects the least net cost of exiting from
the contract, which is the lower of the cost of fulfilling it.

RESTRUCTURING

o A program that is planned and controlled by management.

o It materially changes either in:
 The scope of a business undertaken by an entity; or
 The manner in which that business is conducted

TABULAR SUMMARY OF RESTRUCTURING EXAMPLES

INCLUSIONS IN RESTRUCTURING EXCLUSIONS IN RESTRUCTURING

Sale or termination of a line business Retraining or relocating continuing staff
Closure of business locations or relocation of Marketing
business activities
Changes in management structure or Investment in new systems and distribution
restructuring provision on acquisition (merger) networks
Future operating losses

OTHER COMMON TYPES OF PROVISIONS

 Product warranties and guarantees

 Liability premiums
 Guarantee of indebtedness of other becoming probable
DISCLOSURE
o Reconciliation for each class of provision showing:
Beginning balance Deductions
Additions Ending balance
o Comparative information is NOT required
o For each class of provision, a brief description of the:
 Nature
 Timing
 Uncertainties
 Assumptions
 Reimbursement

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

PROBLEM SOLVING – PROVISIONS, CONTINGENT LIABILITIES, AND CONTINGENT
ASSETS

Intermediate Accounting 2 (Millan)

During 2017, Libya Company is the defendant in a breach of patent lawsuit. The lawyers believe that
there is an 80% chance that the court will not dismiss the case and the entity will incur outflow of
benefits.
If the court rules in favor of the claimant, the lawyers believe that there is a 60% chance that the entity
will be required to pay damages of P2,000,000 and a 40% chance that the entity will be required to
pay damages of P1,000,000. Other amounts of damages are unlikely.
The court is expected to rule in late December 2018. There is no indication that the claimant will
settle out of court.
A 7% risk adjustment factor to the cash flows is considered appropriate to reflect the uncertainties in
the cash flow estimates.
An appropriate discount rate is 10% per year.

Q: What is the measurement of the provision on December 31, 2017?

SOLUTION:
Weighted probabilities:
60% x 2,000,000 x 80% P 960,000
40% x 1,000,000 x 80% 320,000
Expected cash flows 1,280,000
Multiply by risk adjustment factor (100% + 7%) 1.07
Adjusted cash flows 1,369,600
Multiply by PV of 1 at 10% for 1 period 0.91
Present value of cash flows P 1,246,336

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

 PFRS 16 – LEASES (PART 1)

Intermediate Accounting 2 (Millan)

PFRS 16 – prescribes the accounting and disclosure requirements for leases.

– provide information that is faithfully represented, necessary for financial statement users
to assess the effect of leases on financial position, financial performance, and cash flows of an entity.

– applies to ALL leases, including subleases, EXCEPT:

o lease to explore for or use minerals and similar resources;

o leases of biological assets;
o service concession arrangements;
o licenses of intellectual property;
o lessee’s rights under licensing agreements relating to motion picture films, video recordings,
plays, manuscripts, patents, and copyrights.

LEASE

o A contract or part of a contract that conveys the right to use an asset (the underlying asset) for
a period of time in exchange for consideration.
o Parties to a lease contract:
 Lessee – obtains the right to use an underlying asset for a period of time in exchange
for consideration.
 Lessor – provides the right to use an underlying asset for a period of time in
exchange for consideration.

IDENTIFYING A LEASE

o A contract contains a lease if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for consideration.
o An entity has the right to control the use of an identified asset if it has both of the following
throughout the period of use:
 Right to obtain substantially all of the economic benefits from the identified asset
 Right to direct the use of the identified asset

IDENTIFIED ASSET

o Essential in the definition of a lease

o Explicitly stated in the contract or by being implicitly specified at the time the asset is made
available for use.

PORTIONS OF ASSETS

o Physically distinct. Otherwise, it is NOT an identified asset unless it represents substantially

all of the capacity of the asset thereby providing the customer the right to obtain substantially
all of the economic benefits from the asset.

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

SUBSTANTIVE SUBSTITUTION RIGHTS

o It is NOT an identified asset if the supplier has the substantive right to substitute it throughout
the period.
o A supplier’s right to substitute an asset is substantive or not if:

SUBSTANTIVE NOT SUBSTANTIVE

Supplier has the practical ability to substitute Substitution is made only on a particular date
alternative assets throughout the period of use or upon the occurrence of a specified event
Supplier would benefit economically from the Substitution is made only during repairs,
exercise of its right to substitute the asset maintenance or upgrading.

RIGHT TO OBTAIN ECONOMIC BENEFITS FROM USE

o Economic benefits include potential inflows from the asset’s output (directly or indirectly)
o An entity considers only the economic benefits within the defined scope of its rights.
o A contract stipulation requiring the customer to pay additional consideration does NOT
prevent the customer from having the right to obtain substantially all of the economic benefits

RIGHT TO DIRECT THE USE

o Customer has the right to direct the use of an identified asset if:
 He/she has the right to direct how and for what purpose the asset is used.
 The asset’s use is predetermined and the supplier is precluded.
o The following decision making rights may signify the existence of the right to change how
and for what purpose the asset is used:
Right to change where the output is
Right to change the type of output
produced
Right to change whether the output is
Right to change when the output is produced
produced and the quantity of that output

PROTECTIVE RIGHTS

o Includes contractual restrictions designed to protect the supplier’s interest or to ensure

compliance with laws or regulations.
o Define the scope of the customer’s right of use but do NOT prevent the customer from having
the right to direct the use of an asset.

LEASE TERM

o Non-cancellable period (contract is enforceable) of a lease, together with:

 Periods covered by an option to extend the lease if the lessee is reasonably certain to
exercise that option.
 Periods covered by an option to terminate the lease if the lessee is reasonably
certain NOT to exercise that option.
o No longer enforceable when each of the lessor and the lessee can terminate the lease without
permission from the other and subject only to an insignificant penalty.

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

 o In assessing whether a lessee is reasonably certain to exercise an option to extend a lease, or
not to exercise an option to terminate a lease, an entity considers facts that create an
economic incentive for the lessee.
o The shorter the non-cancellable period is, the more likely that a lessee will exercise its
right to extend the lease.
o The lease term begins at the commencement date and includes any rent-free periods.

ACCOUNTING FOR LEASES BY LESSEE

RECOGNITION

o Recognizes lease liability and a right-of-use asset at the commencement date

INITIAL MEASUREMENT OF LEASE LIABILITY

o Initially measured at present value of the lease payments that are NOT yet paid

LEASE PAYMENTS

Lease payments include: Lease payments DO NOT include:

Fixed payments less any lease incentives
receivable
Variable payments initially measured using the
index or rate as at the commencement date
Amount expected to be payable by the lessee
under residual value guarantees
Exercise price of a purchase option
Payment of penalties for terminating the lease
Payment for non-lease elements
Payments in optional extension periods, unless
the extension is ‘reasonably certain’
Future changes in variable payments that depend
on an index or rate
Variable payments linked to the lessee’s future
sales or usage of the underlying asset

DISCOUNT RATE

o Discounted using the interest rate implicit in the lease.

o If rate is not readily determinable, the lessee’s incremental borrowing rate is used.

INTITIAL MEASUREMENT OF RIGHT-OF-USE ASSET

o Initially measured at cost. The cost comprises the following:

Amount of the initial measurement of the lease Any initial direct costs incurred by the lessee
liability

Any lease payments made at or before the The present value of any decommissioning and
commencement date, less any lease incentives restoration costs
received.

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

SUBSEQUENT MEASUREMENT OF LEASE LIABILITY

o Subsequently measured at amortized cost.

SUBSEQUENT MEASUREMENT OF RIGHT-OF-USE ASSET

o Subsequently measured under the cost model EXCEPT when:

 Assets are measured under the revaluation model
 Assets are measured under the fair value model

RECOGNITION EXEMPTIONS

o Short-term leases
o Leases for which the underlying asset is of low value
NON-LEASE ELEMENTS
Maintenance Supply of goods
Security services Supply of operational services
Supply of utilities

PRESENTATION
STATEMENT OF FINANCIAL POSITION
o Rights-of-use assets are presented either:
 Separately from other assets
 Together with other assets as if they were owned, with disclosure of the line items
o Lease liabilities are presented either:
 Separately from other liabilities
 Together with other liabilities, with disclosure of the line items
STATEMENT OF PROFIT OR LOSS AND OTHER COMP. INCOME
o Depreciation and interest expense are presented separately. Interest expense on the lease
liability is a component of finance costs.
DISCLOSURE
Depreciation charge on right-of-use asset Total cash outflow for leases

Interest expense on the lease liability Additions to right-of-use assets

Expense relating to low-value and short-term leases
Expense relating to variable lease payments
Income from subleasing
Carrying amount of right-of-use assets by class of
underlying asset
Additional info on right-of-use assets that are revalued
under PAS 16
Maturity analysis of lease liabilities

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

 PFRS 16 – LEASES (PART 2)

Intermediate Accounting 2 (Millan)

ACCOUNTING FOR LEASES BY LESSOR

RECOGNITION

o A lessor classifies each of its leases as either a finance lease or an operating lease.

CLASSIFICATION OF LEASE BY A LESSOR

o Financial lease (capital lease) – transfers substantially all the risks and rewards.
o Operating lease – DOES NOT transfer substantially all the risks and rewards.
 Risks – possibilities of losses from idle capacity or technological obsolescence.
 Rewards – expectation of profitable operation over the asset’s economic life.
INDICATORS OF A FINANCE LEASE
Transfer of ownership Present value of least payments is at least 90%
of the fair value of the leased asset at the
inception date
Bargain purchase option (BPO) Leased asset is of specialized nature

Lease term is at least 75% of the useful life of

the leased asset

INCEPTION AND COMMENCEMENT OF LEASE

o Inception date – earlier of:
 date of the lease agreement
 date of commitment by the parties to the principal provisions of the lease
o Commencement date – date on which a lessor makes an underlying asset available for use
by the lessee. It is also the date of initial recognition for the lease.
INITIAL MEASUREMENT OF FINANCIAL LEASE
o Receivable measured at an amount equal to the net investment in the lease.
o Financial lease receivable
 Net investment in the lease – “the gross investment discounted at the interest rate
implicit in the lease”
SUBSEQUENT MEASUREMENT OF FINANCIAL LEASE
o Subsequently measured at amortized cost
OPERATING LEASE
o The accounting for operating leases is straight-forward (straight-line method)

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

LEASE OF LAND AND BUILDING
o A lessor assesses the classification of each element as a financial lease or an operating lease
separately.
o A lessor allocates the lease payments to the elements based on their relative fair values at the
inception date.
SUBLEASES
o An underlying asset is released by a lessee to a third party, and the lease between the head
lessor and lessee remains in effect.
o A lessor classifies a sublease as a financial lease or an operating as follows:
 If the head lease is a short-term lease
 Otherwise, the sublease is classified by reference to the right-of-use asset arising from
the head lease.
o If the leased asset is subleased, the head DOES NOT qualify as a lease of a low-value asset.
DISCLOSURE

FINANCIAL LEASES OPERATING LEASES

Selling profit or loss Lease income

Finance income on the net investment in the lease PAS 16 for leases of PPE, disaggregated by class

Income relating to lease variable payments
Qualitative and quantitative explanation of
significant changes in net investment in the base
Maturity analysis of lease receivable
PAS 36 Impairment of Assets, PAS 38 Intangible
Assets, PAS 40 Investment Property and PAS 41
Agriculture
Maturity analysis of lease payments

SALES AND LEASEBACK TRANSACTIONS

o Party sells an asset and immediately leases it back from the buyer.
o Seller becomes the lessee while the buyer becomes the lessor,
o To account, determine whether the transfer qualifies as a sale
TRANSFER OF ASSET IS A SALE OR NOT A SALE

SALE NOT A SALE

The seller/lessee shall measure the right-of-use
asset arising from the leaseback at the proportion
of the previous carrying amount of the asset.
Recognize only the amount of any gain or loss
The seller/lessee continues to recognize the asset
as a financial liability
The buyer/lessor DOES NOT recognize the
transferred asset as a financial asset

The buyer/lessor shall account for the purchase of

the asset applying the Standards

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB

 PROBLEM SOLVING – LEASE (PART 1)

Intermediate Accounting 2 (Millan)

Christian B. Neri BSMA- 2 (MA) MEC 32 - MB