AS – 29 Provisions, Contingent Liabilities and Contingent Assets Paper 5: Advanced Accounting CA. Prathap SS

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Definitions Provision Liability Present Obligation Obligating Event

• A provision is a liability which can be measured only by using a substantial degree of estimation.

• A Liability is a present obligation of the enterprise arising from past events , the settlement of which is expected to result in an outflow of economic resource.

• Present = as on the date of the Balance sheet . • No realistic alternative settlement.

• An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.

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Provisions A provision should be recognised (amount debited to P&L a/c) when An enterprise has a present obligation as a result of a past event .

It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation ; and

A reliable estimate can be made of the amount of the obligation.

If these conditions are not met - No provision should be recognised.

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Other Points Provision should not be calculated at Net Present Value.

It should not be set off against any other asset. It should appear as a separate item in the Liabilities side of the Balance Sheet.

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Contingent Liability

A possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise .

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Contingent Liability

A present obligation that arises from past events but is not recognised because :

Note

• It is not probable that an outflow of resources to settle the obligation. • A reliable estimate of the amount of the obligation cannot be made.

• An enterprise should not recognise a contingent liability but it has to be disclosed by way of Footnote.

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Contingent Asset

A contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the enterprise.

Note: An enterprise should not recognise a contingent asset.

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Disclosure For each class of Provision, an enterprise should disclose: The carrying amount at the beginning and end of the period. Additional provisions made in the period , including increases to existing provisions. Amounts used ( i.e., incurred and charged against the provision) during the period ; and Unused amounts reversed during the period

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Disclosure (contd..)

An enterprise should disclose the following for each class of provision : A brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits.

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Disclosure requirements for Contingent Liability An enterprise should disclose for each class of contingent liability at the Balance Sheet date a brief description of the nature of the contingent liability and , where practicable : An estimate of its financial effect

An indication of the uncertainties relating to any outflow

The possibility of any reimbursement

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Exam Problems

Problem - 1

What are the disclosure requirements pertaining to contingencies ?

(2 marks, May 1998)

Disclosure requirements for Contingent Liability An enterprise should disclose for each class of contingent liability at the Balance Sheet date a brief description of the nature of the contingent liability and , where practicable : An estimate of its financial effect

An indication of the uncertainties relating to any outflow

The possibility of any reimbursement

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Problem - 2 An airline is required by law to overhaul its aircraft once in every 5 years . The Pacific Airlines which operates aircrafts does not provide any provision as required by law in its final accounts. Discuss with reference to relevant AS – 29

(May 2012 , 4 marks)

Solution A provision should be recognized as per Para 14 of AS-29 , only when an enterprise has a present obligation as a result of a past obligating event . In the given case , there is no present obligation ( i.e., as on date of B/S ) , therefore no provision is recognized as per AS-29

Solution ( contd…) Even a legal requirement to overhaul does not require the company to make a provision for the cost of overhaul , because there is no present obligation to overhaul the aircrafts. Further , AS-29 says that an enterprise should have no realistic alternative to settle the obligation . Here , the enterprise can avoid the future expenditure by its future action of selling the aircraft.

Problem - 3 X Ltd has its financial year ended 31.03.2009, fifteen law suits outstanding, none of which has been settled by the time the accounts are approved by the directors. The directors have estimated that the probable outcomes as below: Result

Probability Amount of Loss

For first ten cases : Win

0.6

_

Lose-low damages

0.3

90,000

Lose-high damages

0.1

2,00,000

For remaining five cases : Win

0.5

_

Lose-low damages

0.3

60,000

Lose-high damages

0.2

1,00,000

Problem – 3 (contd..)

The directors believe that the outcome of each case is independent of the outcome of all the others.

Estimate the amount of contingent liability and state the accounting treatment of such contingent liability.

(May 2010 , 4 marks)

Solution 15 court cases (law suites) come under the definition of Contingent Liability.

As per AS-29 , the contingent liability cannot be recognized , i.e., it cannot be debited to P&L . It has to be disclosed only by way of footnote.

Para 68 of AS-29 requires an enterprise should disclose where possible & estimate of the financial effect of the Contingent Liability on a best estimate basis.

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Solution (contd..)

In the first 10 cases , there is 0.6% probability of success , this has to be ignored.

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Solution (contd….) Cases 1-10

11-15

Total :

Expected Loss per case 0 *0.6 + 0.3 * 90,000 + 0.1 * 2,00,000 = 47,000 0 *0.5 + 0.3 * 60,000 + 0.2 * 1,00,000 = 38,000

Total Expected Loss

4,70,000(47,000*10)

1,90,000 (38,000 * 5) 6,60,000

Solution ( contd..) An amount of Rs. 6,60,000 should be disclosed as a contingent Liability by way of a Footnote , with regard to the 15 law suits pending as on the Balance Sheet date.

Problem - 4

A company is in dispute involving allegation of infringement of patents by a competitor company who is seeking damages of a huge sum of Rs.900 lakhs.

The directors are of the opinion that the claim can be successfully resisted by the company. How would you deal with the same in the annual accounts of the company ?

(Nov – 2012 , 4 marks)

Solution This Case comes under AS-29 , “Provisions , Contingent Liability , Contingent Asset”

Dispute which is pending in the court is a Contingent Liability as per Para 10 of AS-29. As per Para 26 , an enterprise should not recognize Contingent Liability .

So , the amount of Rs. 900 Lacs will not be debited in the P & L of the company.

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Solution (contd..)

However Para 68 requires an enterprise to disclose the amount of Contingent Liability as a footnote to the B/s , with a brief description of the nature of the liability & this disclosure has to be made by the company

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