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Provisions and Contingencies Slides

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    http://www.cc.cec/budg/

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    2 PwC

    Overview of session

    1. Scope of application

    2. Key concepts

    3. Recognition

    4. Measurement

    5. Disclosures

    6. Specific implications / Next steps

    7. Questions

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    1. Scope of application

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    4 PwC

    Scope

    Covers accounting for all provisions and contingencies,

    excluding:

    Social benefits provided by an entity for which it does not receive

    consideration that is approximately equal to the value of goods or

    services provided

    Provisions resulting from financial instruments carried out at fair

    value

    Provisions arising in relation to income taxes

    Employee benefits (except those that arise as a result of a

    restructuring)

    Provisions covered by another IPSAS

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    2. Key concepts

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    6 PwC

    Legal and constructive

    obligations

    Legal obligation= an obligation that derives from:

    A contract (through its explicit or implicit terms); or

    Legislation; or

    Other operation of law

    Constructive obligation= an obligation that derives from an entitys

    action where:

    By an established pattern of past practice, published policies orsufficiently specific current statement, the entity has indicated to other

    parties that it will accept certain responsibilities; and

    As a result, the entity has created a valid expectation on the part of those

    other parties that it will discharge its responsibilities.

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    Liabilities and provisions

    Liabilities= present obligations (legal or implicit) of the entity

    arising rom past events, the settlement of which is expected to

    result in an outflow from the entity of resources embodying

    economic benefits or service potential

    Provisions= a special category of liabilities = liabilities of

    uncertain timing and amount

    There must be a clear present obligation from a past obligating

    event

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    8 PwC

    Provisions Write-downs

    Provisions

    On the liabilities side

    Present obligations resulting

    from past events

    Write-downs

    To reduce the carrying value ofassets

    E.g. write-down of inventories tonet realisable value; write-down ofproperty, plant and equipment torecoverable amount

    Provisions should not be recognised for future

    operating losses. An expectation of futureoperating losses is an indication that certain

    assets of the operation may be impaired. In

    this case, an enterprise tests these assets for

    impairment.

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    9 PwC

    Contingent liabilities and

    contingent assets

    Contingent liabilities=

    Possible obligations that arise from past events and whose

    existence will be confirmed only by the occurrence or non-

    occurrence of one or more uncertain future events not whollywithin the control of the entity

    Present obligations that arise from past events but are not

    recognised because:

    It is not probable that an outflow of resources embodying economic

    benefits or service potential will be required to settle the obligation; or

    The amount of the obligation cannot be measured with sufficient

    reliability

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    3. Recognition

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    12 PwC

    Provisions - Recognition

    A provision should be recognised as a liabilityin the balance

    sheet andas an expensein the economic outturn account

    when:

    An entity has a present obligation(legal or constructive) as a

    result of a past event; and

    A reliable estimatecan be made of the amount of the obligation;

    and

    It is probablethat an economic outflow of economic resources

    embodying economic benefits or service potential will be required

    to settle the obligation.

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    13 PwC

    Provisions - Recognition

    Decision Tree

    Present

    obligation as a result of an

    obligating event?

    Probable

    Outflow?

    Reliable

    estimate?

    Possible

    obligation?

    Remote?

    Start

    ProvideDisclose contingent

    liabilityDo nothing

    yesno

    no

    nono

    yes

    yes

    yesyes

    no

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    14 PwC

    Examples

    Item True/False

    1. Warranties given where some claims are more likely than not

    2. Board decision which has not been communicated to those affected

    3. Future operating losses

    4. Pollution that an entity is obliged to clean up

    5. Staff retraining needed as a result of law changes

    6. Court case where a loss seems more likely than not

    7. Repairs and maintenance

    8. Single guarantee for which there is no probable outflow of economic

    benefits

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    15 PwC

    Specific application of

    recognition criteria

    Restructuring provisions

    Programme which materially changes scope of business

    Following two conditions need to be met to be recorded as

    provision

    Detailed plan identifying key features of programme and its

    implementation must exist at balance sheetdate

    Must be valid expectation that business will undergo restructuring

    Can only include direct expenses associated with restructuring

    programme; cannot relate to ongoing operation of business

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    P

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    4. Measurement

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    18 PwC

    Measurement

    Best estimate at balance sheet date of amount needed

    to settle obligation

    If range is predicted with all the same likelihood of

    occurrence, mid point must be selected Large population of itemsexpected value

    measurement

    Anticipated cash flows must be discounted at risk free

    rate where changing value of money over time ismaterial:

    - Carrying value of liability increases by imputed interest

    in each period; recognised as interest expense in

    income statement

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    19 PwC

    Measurement

    Worked example

    A government medical laboratory provides diagnostic

    scanners with a one-year guarantee for parts and

    labour.

    Experience indicates that 70% of the diagnosticscanners will not be the subject of warranty claims, 25%

    will have minor defects and 5% will require replacement

    or major work. 100,000 units were provided in the

    current year. Major repair or replacing the unit costs

    approximately 25. Minor repairs cost 5 each.

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    20 PwC

    Measurement

    - Worked example

    The estimated warranty expense and the warranty provision should be determined by

    applying the probability of each outcome to the cost of each outcome as follows:

    Expected Value

    70% x nil nil

    25% x 100,000 x 5 125,000

    5% x 100,000 x 25 125,000

    Estimated warranty expense 250,000

    The warranty provision will be reduced to the extent of costs already incurred in

    respect of warranty claims on vacuum cleanerssold during the year.

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    21 PwC

    Measurement

    - Worked example

    The E.C. have litigation pending. Legal advice is that the E.C. will lose the case, and costs

    of1,200 in two years time are estimated. The appropriate discount rate is 4.5 %.

    Discount factor at4.5%

    NPV Cash flows Additional costs

    At inception 0.9157 1,099 -

    Year 1 0.9569 1,148 - 49

    Year 2 1.0000 1,200 1,200 52

    Economic outturn

    accountBalance sheet

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    22 PwC

    Other issues

    Reimbursement:

    To be recognised when, and only when, it is virtually certain that

    reimbursement will be received if the entity settles the obligation

    The reimbursement should be treated as a separate asset

    In the economic outturn account, the expenses relating to a

    provision may be presented net of the amount recognised for the

    reimbursement

    Use of provision:

    A provision should be used only for expenditures for which the

    provision was originally recognised.

    P C

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    5. Disclosures

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    24 PwC

    Disclosures - Provisions

    Key disclosures required:

    Accounting policies for each major type ofprovision (for example, warranties)

    Movements in provisions during the period

    Descriptions of contingent liabilities and

    contingent assets

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    25 PwC

    Disclosures - Guarantees

    Guarantees for pre-financing received for procurement and for

    grants

    Performance guarantees:

    Regular performance guarantees: disclose

    Specific guarantees related to performance guarantees: do not

    disclose but consider as they are automatically activated and are

    in essence a liability towards the contractor

    Guarantees given or received by the DG ECFIN for borrowingsand loans

    Guarantees received by the DG BUDG when fines are disputed

    P C

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    PwC

    Provisions,

    Contingent Liabilities

    and Contingent Assets

    6. Specific implications /

    Next steps

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    27 PwC

    Ensuring compliance with

    the new rules

    Caption Provision under

    IPSAS 19?

    Comments Current treatment

    Dismantlement of

    nuclear installations

    Yes Annual estimates Yes

    Pensions +

    employee benefits

    Yes Yes

    Food-and-mouth

    disease

    Yes Minimum in the range of

    possible outcomes

    Maximum possible outcome

    disclosed

    Yes

    Legal disputes Yes On a case by case basis Yes

    PwC

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    PwC

    Provisions,

    Contingent Assets and

    Contingent Liabilities

    7. Questions

    http://www.cc.cec/budg/


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