TUTORIAL 4 SOLUTION Provisions are liabilities (as defined by the framework) for which the amount or timing of the expenditure that will be undertaken is uncertain. IAS 37 clarifies that in order for there to be a present obligation there must be an obligating event. Obligating events may take the form of: · a legal obligation, or · a constructive obligation. In respect of legal obligations there is only an obligating event if, and only if, settlement of the obligation can be enforced by law. In respect of constructive obligations (i.e. a present obligation that arises from normal business practice or custom, and a desire to maintain good business relationships) there is only an obligating event if, and only if, the event creates a valid expectation in other parties, which the reporting enterprise has no reasonable alternative but to settle. In order to recognise a provision both of the framework recognition criteria for a liability must be satisfied. In this regard IAS 37 clarifies that probable means 'more likely than not' (i.e. a > 50% probability). IAS 37 also provides that provisions should not be raised in respect of future operating losses, except where such losses arise in respect of onerous contracts. In the context of provisions, onerous contracts are contracts in which the unavoidable costs of meeting the contractual obligations exceed the benefits to be derived there from. Each of the provisions that the financial director seeks to raise is tested against the definition and recognition criteria for provisions below. The test will initially be applied to see if there is an obligating event giving rise to a present obligation and if this criteria is failed no further tests will be conducted as no provision could in accordance with IAS 37 be raised. Liabilities, Provisions & Contingent Liabilities Page 1 of 3
DEFINITION of a liability: Major Maintenance Environment Restoration a present obligation of the reporting enterprise Not satisfied, as there was no legal or constructive obligation to carry out the repairs at the end of the reporting period and the company can avoid incurring this expenditure in the future. Not satisfied, although the company's board had approved a detailed formal plan to carry out the expenditure they had not raised a valid expectation in other parties before the end of the reporting period (i.e. at the end of the reporting period this was avoidable expenditure). The announcement in the AFS is too late to give rise to a constructive obligation at 31 Dec 20.5. Audit Fees It is argued that there is no present obligation arising from the legal requirement to have an audit as with regard to legal obligation IAS 37 only allows provisions to be raised where settlement of the obligation can be enforced by law in this case it cannot as no audit work has been performed. However, this expenditure cannot be avoided. It can be argued that there is a constructive obligation for an audit to be conducted then a provision would be raised.