Important terms of AASB 137 related to contingent liabilities and provisions

In this letter an attempt is made to provide response to the email received from you containing certain accounting issues faced by your company. An effort has been made in the letter to present clear conception about the situation then a legitimate accounting treatment has been suggested. In pursuance of this the provisions laid down in AASB has been referred extensively. It is expected that via this letter the problems or issues faced by the company will be effectively and efficiently eradicated.

On critically analysing the case provided it can be seen that the issues raised should be addressed by refereeing to the AASB 137. The main reason for suggesting the changes is the application of various requirement provided in the different para graphs of the standard AASB 137. Therefore, prior to explaining the current case the few important terms that are relevant to the case are contained in the Para 10 of the AASB 137 regarding some key and relevant financial items are explained (Tran and Zhu 2017).

As per the AASB a provision is that kind of a liability which has an uncertain time and amount associated with it.

Contingent Liability:

It is defined as

1. An obligation which may possibly arise out of past events and its actuality will be substantiated by the happening or non-happening of one or more future events that is uncertain which are not wholly within the control of the management or company (Crawford et al. 2014).
2. A current obligation that has arisen out of past events but is not recognised due to:
3. Less chances of an outflow of resources embodying economic benefits being required for the settlement of the obligation
4. The amount that is required to settle the obligation cannot be established reliably based on the available information.

It can be said that due to uncertainty in the amount and the timing of the occurrence in general perception it is assumed that all the provisions are contingent because of the uncertainty in the amount and timing of their occurrence. But, the standard in Para 12 and Para 13 has made a clear distinction between the provisions and contingent liabilities. Contingent liabilities will only be those liabilities whose existence depends on the occurrence or non-occurrence of an uncertain event in future that is beyond the whole control of the entity. Moreover, those liabilities will also be termed as contingent which does not fulfil the recognition criteria (Tran 2015).

The accounting treatment of the event is dependent on the recognition criteria stated in the accounting standards.

Provisions:

An entity shall recognise the provision only if the following conditions are fulfilled:

• The present obligation have been incurred by the entity as a result of its past events
• It is probable that outflow of economic resources will be required to the settle the present obligation.
• The amount of the provision can be established reliably (Kabir and Rahman 2016).

The contingent liabilities of an entity are not recognised in the financial statements of the entity.

The Para 84 of the standard provide the disclosure requirements that are stated in the AASB 137. The company in the current case will have to provide the disclosures that are mentioned in the standard (Taylor and Richardson 2014). For respective classes of provision the organisation will have to disclose the following:

1. The respective carrying amount of the provision at the beginning and the end of the reporting period.
2. Information regarding any addition made to the existing provisions or any new provisions made
3. Amount that has been charged against the provision for the reporting period.
4. The amount that has been reversed during the period.

Accounting treatment of contingencies under AASB 137

In respect of the contingent liability the entity will disclose the below given disclosures only if there is a very little chance of an outflow of resources embodying economic benefits in respect of it. The disclosures to be made are as follows:

1. The financial effect of the item as per the estimations made by the management.
2. There is an indication of uncertainties in the amount or timing of the outflow.
3. There is possibility that there is a requirement for reimbursement.

The first case relate to the disclosure requirement and the accounting treatment of the legal claim. The company is currently facing a case for patent infringement from its competitors. The compensation that have been claimed is $87 million. The hearing is scheduled on July 2018 and it is estimated that there is 30% chance that the company will be found guilty and will have to pay the full compensation (Adighibe 2015). There is also 60% and 40% chance of paying compensation of $50 million and $30 million respectively. In the current case at the time of the approval of the financial statement there is no present obligation as a result of past events. As a result based on the above discussion it can be said that no provision is recognised in the financial statement. The Para 86 of the standard provides that the matter should be disclosed as the contingent liability provided that there is no probability of the outflow is remote (Loyeung and Matolcsy 2015). If however, it is practicable then an estimate of the financial effect should be measured. In this case it can be said that the company should recorded the contingent liability in the financial statement as there are possibility of reimbursement.  Therefore in the note the company should state that possible obligations are $24 million, $30 million and $12 million.

In the current situation your company has made a sale of equipment had been made on 12^th December 2017, the delivery of the goods was scheduled for 22^nd December 2017 and the payment of the same will be made on 31^st December 2017. Within the sale agreement a clause of provision of maintenance services is included wherein the company will be providing maintenance for the next 12 months from the date of delivery. If the maintenance is not given properly the customer is entitled to receive a 15 % refund. Your company has made an estimation of the maintenance expense as $15000.      

As per the analysis made the company will have to make the accounting entries in the following manner:

1. The company should recognise the sale on 12^th December i.e. on the date of agreement for sale because there is no uncertainty regarding the collection of the amount and the delivery of the item to the customer (Hodgson and Russell 2014).
2. A provision has to be made for the maintenance charges by crediting provision for maintenance account and debiting the maintenance and repair account. The maintenance and repair account will go the profit and loss account of the company whereas the provision for maintenance account will go to the balance sheet. The recognition of the provision has to be made because it is fulfilling all the criteria for recognition as mentioned above (Adhariani et al. 2017).
3. A contingent liability has to be disclosed in the notes to accounts of the financial statements of the company because the refund is dependent upon the quality of the service provided by the company. As the refund is dependent upon happening or non-happening of an uncertain event it is disclosed as a contingent liability (Tahat et al. 2016).

Conclusion and recommendations:

While giving the requisite recommendation due care has been taken to refer to the relevant provisions of the AASB. In the first case, it is recommended that the company should record the contingent liability in the financial statement and provide a sufficient estimate. In the second case, the company has been advised to make a provision for the amount estimated by it for the maintenance services to be provided as the item has met all the criteria for recognition. At the same time a contingent liability has to be recorded in the notes to accounts of the financial statements of the company as the service quality offered by the company to the customer is an uncertain event and the obligation is dependent upon its happening and non-happening. In addition to that the recording time of the sale of the equipment in the books have been recommended to the company    

Thanking You 

Reference

Adhariani, D., Sciulli, N. and Clift, R., 2017. Corporate Governance Practices from the Ethics of Care Perspective. In Financial Management and Corporate Governance from the Feminist Ethics of Care Perspective (pp. 49-80). Springer International Publishing.

Adighibe, C.N., 2015. Public private partnership infrastructure delivery: Benefits and costs for society (Doctoral dissertation, Queensland University of Technology).

Crawford, L., Lont, D. and Scott, T., 2014. The effect of more rules?based guidance on expense disclosure under International Financial Reporting Standards. Accounting & Finance, 54(4), pp.1093-1124.

Hodgson, A. and Russell, M., 2014. Comprehending comprehensive income. Australian Accounting Review, 24(2), pp.100-110.

Kabir, H. and Rahman, A., 2016. The role of corporate governance in accounting discretion under IFRS: Goodwill impairment in Australia. Journal of Contemporary Accounting & Economics, 12(3), pp.290-308.

Loyeung, A. and Matolcsy, Z., 2015. CFO’s accounting talent, compensation and turnover. Accounting & Finance, 55(4), pp.1105-1134.

Tahat, Y.A., Tahat, Y.A., Dunne, T., Dunne, T., Fifield, S., Fifield, S., Power, D.M. and Power, D.M., 2016. The impact of IFRS 7 on the significance of financial instruments disclosure: Evidence from Jordan. Accounting Research Journal, 29(3), pp.241-273.

Taylor, G. and Richardson, G., 2014. Incentives for corporate tax planning and reporting: Empirical evidence from Australia. Journal of Contemporary Accounting & Economics, 10(1), pp.1-15.

Tran, A. and Zhu, Y.H., 2017. The impact of adopting IFRS on corporate ETR and book-tax income gap. In Australian Tax Forum (Vol. 32, No. 4, p. 757). Tax Institute.

Tran, A., 2015. Can taxable income be estimated from financial reports of listed companies in Australia?. Browser Download This Paper.