PROVISIONS Legal obligation v.

Constructive Obligation

A provision is a liability of uncertain timing or amount, sometimes referred to as Legal obligation – generally results from a contract or legislation
an estimated liability.

Provision vs. Other Liabilities

Provisions di8er from other types of liabilities in that provisions have
greater uncertainty concerning the timing or amount of the future
expenditure required to settle the obligation.

Common types of provisions are obligations related to litigation,

warrantees or product guarantees, business restructurings, and
environmental damage.

RECOGNITION OF PROVISIONS
Requisites to accrue expense and liability for a provision:
(a) a company has a present obligation as a result of a past event; Constructive obligation – an obligation that derives from a company’s actions
where:
TN: Legal obligation v. Constructive Obligation
(a) by an established pattern of past practice, published policies, or a
(b) it is probable that an outflow of resources embodying economic su8iciently specific current statement, the company has indicated to
benefits will be required to settle the obligation; other parties that it will accept certain responsibilities; and

TN: 51% (b) as a result, the company has created a valid expectation on the part of
those other parties that it will discharge those responsibilities.
(c) a reliable estimate can be made of the amount of the obligation.
TN: Best estimate
Range of possible outcomes – midpoint of the range (assume each
point is as likely as the other)
Large population of items – expected value (weight)
 Litigation Provisions Service-type warranty - is sold separately from the product, usually as an
When a company is threatened with legal action (pending, threatened, unfiled extended warranty.
suits, or unasserted claims and assessments), the recording of a liability will *This type of warranty is recorded as a separate performance
depend on certain factors: obligation. The sale of a service-type warranty is recorded as
(a) the time period in which the underlying cause of action occurred; Unearned Warranty Revenue. The company then recognizes
(b) the probability of an unfavorable outcome; and, revenue over the period of the warranty on a straight-line basis.
(c) the ability to make a reasonable estimate of the amount of the loss.
ENTRIES ENTRIES

a. Assurance-type warranty

(1) Cost is included in the sales price.

(2) The entry made at the time of sale:

Warranty Expense ................................... XX

Warranty Liability ............................... XX

(3) The entry made when incurring warranty costs:

Warranty Liability .................................... XX

Cash, Inventory, Accrued Payroll ........ XX
Warranty Provisions
A warranty (product guarantee) represents a promise by a seller to a buyer to make --- --- --- --- --- --- ---
good on any deficiency of quantity, quality or performance specifications in a
product. b. Service-type warranty

Assurance-type warranty - guarantees the product (service) meets (1) Sold separately from the product as an extended warranty.
agreed-upon specifications in the contract at the time of the sale and is
included in the sales price. (2) The entry made to record the sale of warranty:
*Companies do not record a separate performance obligation for
this type of warranty. The estimated costs and liability are recorded Cash........................................................ XX
at the point of sale with a debit to Warranty Expense and a credit to Unearned Warranty Revenue ............ XX
Warranty Liability. As warranty costs are incurred, the Warranty
(3) The entry made at year-end to recognize revenue:
Liability account is debited and various other accounts are
credited.
Unearned Warranty Revenue ................. XX
Warranty Revenue ............................. XX
 Consideration Payable (Premium) Environmental Laiebality Provisions
If a company o8ers premiums to customers in return for coupons, a liability
should normally be recognized at year-end for outstanding premium oIers a. Included in the cost of the related asset at the present value of
expected to be redeemed. The liability should be recorded along with a charge the environmental costs.
to a premium expense account. (premiums, coupons, rebates)
b. The environmental costs are allocated to expense over the
useful life of the related asset through depreciation.

c. Interest expense is accrued each period by increasing the

environmental liability.

d. The liability is eliminated when the related asset is retired and

the retirement activities have been performed.

Onerous contract provisions

a. Exist when the unavoidable costs of meeting the obligations

exceed the economic benefits expected to be received.

b. Expected costs, and related liability, should reflect the least

net cost of exiting from the contract, which is the lower of:

(1) The cost of fulfilling the contract, or

(2) The compensation or penalties arising from failure to

fulfill the contract.

Restructuring provisions
a. IFRS is very restrictive in permitting restructurings and what types of
costs may be included. (accounting is controversial)

b. Defined as a program that is planned and controlled by

management and materially changes either:
(1) The scope of a business undertaken by a company, or

(2) The manner in which that business is conducted.

 Disclosures
c. Companies are also required to have a detailed formal restructuring The disclosures related to provisions are extensive. A company must provide a
plan and to have raised valid expectations to those a8ected by reconciliation of its beginning to ending balance for each major class of
implementing or announcing the plan. provisions, identifying what caused the change during the period. In addition, the
provision must be described and the expected timing of any outflows
d. Only direct incremental costs associated with the restructuring are disclosed. Also, disclosure about uncertainties related to expected outflows as
includable in the provision. well as expected reimbursements should be provided.

e. The IFRS provides specific guidance concerning which costs and Contingencies
losses are excluded from restructuring costs.
Contingent liabilities

a. Are not recognized in the financial statements because they are:

(1) A possible obligation (not yet confirmed as a present

obligation),

(2) A present obligation for which it is not probable that payment

will be made, or

(3) A present obligation for which a reliable estimate of the

obligation cannot be made.
Self-insurance
b. General guidelines for accounting and reporting contingent
a. The absence of insurance does not mean that a liability has been liabilities are:
incurred at the date of the financial statements.
(1) If it is virtually certain that a liability will occur (probability at
b. An accrual is required if: least 90%), record the liability.

(2) If it is probable that a liability will occur (probability 51–89%),

(1) Uninsured losses resulting from injury to others or damage
record the liability.
to other’s property took place prior to the date of the
financial statements, and (3) If it is possible but not probable that a liability will occur
(probability 5–50%), only the disclosure is required.
(2) A reasonable estimate of the amount can be made.
(4) If it is remote that a liability will occur (probability less than
5%), no disclosure is required.
c. Disclosure should include:

(1) A brief description of the nature of the contingent liability,

CONTINGENT LIABILITY GUIDELIBNES:
(2) An estimate of its financial effect,

(3) An indication of the uncertainties relating to the amount or

timing of any outflow, and

(4) The possibility of any reimbursement.

Contingent assets

a. A possible asset that arises from past events and whose existence
will be confirmed by the occurrence or non-occurrence of uncertain CONTINGENT ASSET GUIDELINES:
future events not wholly within the control of the company.

b. General guidelines for accounting and reporting contingent assets

are:

(1) If it is virtually certain that an asset will occur (probability at

least 90%), report as an asset (no longer contingent).

(2) If it is probable that an asset will occur (probability 51–89%),

disclosure is required.

(3) If it is possible that an asset will occur (probability 5–50%),

no disclosure required.

(4) If it is remote that an asset will occur (probability less than

5%), no disclosure required.
 Customers presented 3,000 of the coupons for redemption in 2022. Customers have
PRACTICE PRACTICE PRACTICE until June 30, 2023 to present coupons in exchange for a free hat. Estimates indicate
that a total of 50% of the coupons will eventually be presented for redemption.
Simbaaa Company offers a cash rebate of $0.25 on each $12 package of fish
Instructions
food sold during 2022. Historically, 10% of customers mail in the rebate form.
Prepare all the entries that would be made relative to sales of the golf balls
During 2022, 5,000,000 packages are sold, and 150,000 $0.25 rebates are included in the promotion and to the golf hat premium plan in 2022.
mailed to customers. What is the rebate expense and liability, respectively,
reported in the company’s 2022 financial statements?
a. $125,000; $37,500
b. $37,500; $87,500
c. $125,000; $125,000
d. $125,000; $87,500

In 2021, Ursula Corporation began selling a new line of products that carries a
two-year warranty against defects. Based upon past experience with other
products, the estimated warranty costs related to dollar sales are as follows:

First year of warranty 2%

Second year of warranty 5%

Sales and actual warranty expenditures for 2021 and 2022 are presented below:

2021 2022
Sales €600,000 €800,000
Actual warranty expenditures 20,000 40,000

What is the estimated warranty liability at the end of 2022?

a. $38,000
b. $58,000
c. $98,000
d. $16,000

Mitchell Golf Stores, IAG operates a chain of golf equipment stores in the Germany.
In 2022 the company ran a promotion, providing customers with coupon each time a
customer bought a dozen of a specific brand of golf balls. After accumulating five
coupons, a customer could present the coupons to the store in exchange for a free
golf hat. In 2022, Mitchell purchased 1,100 of the hats for the promotion at €7.00
each and sold 9,500 dozen golf balls eligible for the promotion at €50 per dozen.