Chapter 13

Current Liabilities, Provisions and

Contingencies
LO2
Accounting for Provisions
ACCT 220
FALL 2020

13-1
 PROVISIONS

Provision is a liability of uncertain timing or amount.

Reported either as current or non-current liability.

Common types are

► Obligations related to litigation. How is it diff from ot
current liabilities?
► Warrantees or product guarantees.
► Business restructurings.
Uncertainty about the
► Environmental damage. timing or amount of
the future expenditure
required to settle the
obligation.

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 Recognition of a Provision

Companies accrue an expense and related liability for a

provision only if the following three conditions are met:
1. Present obligation (legal or constructive);

2. Probable that an outflow of resources;

3. A reliable estimate can be made.

Key Words:
Obligation
Probable
Estimate
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 Recognition of a Provision

Constructive obligation – established due to an action

1. Indicated to customers that it will accept certain responsibilities;
and

2. Valid expectation by customers to discharge those

responsibilities.

e.g.
• Warranties
• Coupons, Loyalty cards

13-4
 Measurement of Provisions
BEST ESTIMATE

• Use judgment

• Time value of money

• Future events (What if your liability is in another currency?)

Methods commonly used

- Use probability to arrive at expected value
- Use a midpoint in a range or an average value
- Most likely outcome

13-5
 Common Types of Provisions

Common Types:
1. Lawsuits 4. Environmental

2. Warranties 5. Onerous contracts

3. Consideration payable 6. Restructuring

• IFRS requires extensive disclosure related to provisions in the

notes to the financial statements.
• Do not record or report in the notes general risk contingencies
inherent in business operations (e.g., the possibility of war, strike,
uninsurable catastrophes, or a business recession).
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 Litigation Provision
Pending or threatened litigation, Unfiled suits and unasserted
actual or possible claims and claims and assessments,
assessments. 1. Probability of occurrence
1. Time period 2. The probability of an
2. The probability of an unfavorable outcome.
unfavorable outcome.
If both are probable, if the loss is
3. Reasonable estimate of the reasonably estimable, and if the
amount of loss. cause for action is dated on or
before the date of the financial
statements, then the company
should accrue the liability.
13-7
 Common Types of Provisions

Warranty Provisions
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims and

a company can reasonably estimate the costs involved, the
company must record an expense.

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 Types of Warranties
Assurance-Type Service-Type
Quality guarantee at the point of An extended warranty on the
sale. product at an additional cost.
• Obligations should be • Unearned Warranty Revenue
expensed at the point of sale account. (Cr)

• Company should record a • Recognize revenue on a

warranty liability. straight-line basis over the
Dr Cash period the service-type
Dr Warranty Expense warranty is in effect.
Cr Warranty Liability Dr Unearned Warranty Revenue
Cr Sales Revenue Cr Warranty Revenue
13-9
 Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for $5,000
cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2015 and $16,000 in 2016.

Question: What are the journal entries for the sale and the
related warranty costs for 2015 and 2016?

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

1. To recognize sales of machines and accrual of warranty

liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

2. To record payment for warranties incurred:

July–December 2015

Warranty Liability 4,000

Cash, Inventory, Accrued Payroll 4,000

The December 31, 2015, statement of financial position reports

Warranty Liability as a current liability of $16,000. The income statement
for 2015 reports Warranty Expense of $20,000.

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 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

3. To record payment for warranty costs incurred in 2016

related to 2015 machinery sales:

January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery

sold in 2015.

13-13
 Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000

on January 2, 2014. Hamlin estimates the assurance-type
warranty costs on the automobile to be €700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2014 and 2017?

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 Service-Type Warranty

Solution:

1. To record the sale of the automobile and related

warranties:

January 2, 2014

Cash (€30,000 + €900) 30,900

Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000

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 Service-Type Warranty

Solution:

2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 500

Cash, Inventory, Accrued Payroll 500

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 Service-Type Warranty

Solution:

3. To record revenue recognized in 2017 on the service-

type warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (€900 ÷ 3) 300

Warranty Revenue 300

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 Common Types of Provisions

Consideration Payable
Companies often make payments (provide consideration) to
their customers as part of a revenue arrangement.

Companies offer premiums, coupon offers, and rebates to

stimulate sales.
 Companies should charge the costs of premiums and
coupons to expense in the period of the sale that
benefits from the plan.

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 Consideration Payable

Facts: Fluffy Cake Mix Company sells boxes of cake mix for £3
per box. In addition, Fluffy Cake Mix offers its customers a large
durable mixing bowl in exchange for £1 and 10 box tops. The
mixing bowl costs Fluffy Cake Mix £2, and the company estimates
that customers will redeem 60 percent of the box tops. The
premium offer began in June 2015. During 2015, Fluffy Cake Mix
purchased 20,000 mixing bowls at £2, sold 300,000 boxes of cake
mix for £3 per box, and redeemed 60,000 box tops.

Question: What entries should Fluffy Cake Mix record in 2015?

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 Consideration Payable

Solution:

1. To record purchase of 20,000 mixing bowls at £2 per

bowl:

Premium Inventory (20,000 bowls x £2) 40,000

Cash 40,000

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 Consideration Payable

Solution:

2. Before Fluffy Cake Mix makes the entry to record the

sale of the cake mix boxes, it determines its premium
expense and related premium liability. This
computation is as follows.

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 Consideration Payable

Solution:

2. The entry to record the sale of the cake mix boxes and
premium expense and premium liability is as follows.

Cash (300,000 boxes x £3) 900,000

Premium Expense 18,000
Sales Revenue 900,000
Premium Liability 18,000

13-22
 Consideration Payable

Solution:

3. To record the actual redemption of 60,000 box tops, the

receipt of £1 per 10 box tops, and the delivery of the
mixing bowls:

Cash [(60,000 ÷ 10) x £1] 6,000

Premium Liability 6,000
Premium Inventory [(60,000 ÷ 10) x £2] 12,000

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Common Types of Provisions - Environmental
RECOGNITION
• existing legal obligation associated with the retirement of a long-lived
asset and
• reasonably estimate the amount of the liability.
Examples
Nuclear facilities, oil and gas properties,

MEASUREMENT
best estimate of its future costs (discount rate)

13-24
 Environmental Provisions

Recognition and Allocation

1) Initial entry

Dr Long-lived asset

Cr Environmental Liability

2) Depreciate Asset

3) Record interest expense and increase the liability

4) Once facility is dismantled discharge the liability and

book gain or loss

13-25
Common Types of Provisions – Onerous Contract

RECOGNITION
Unavoidable costs of Economic benefits expected to
meeting the obligations
> be received from the contract

MEASUREMENT : least net cost to exit the contract

Lower of
a . the cost of fulfilling the contract,

b. the compensation or penalties if contract not fulfilled

Dr Loss on Lease Contract

Cr Lease Contract Liability
13-26
Common Types of Provisions - Restructuring

Restructurings are defined as a “program that is planned and

controlled by management and materially changes either
1. the scope of a business undertaken by the company; or

2. the manner in which that business is conducted.”

Companies are required to have a detailed formal plan for the restructuring
and to have raised a valid expectation to those affected by implementation
or announcement of the plan.

13-27
 Restructuring Provisions

IFRS provides specific guidance related to certain costs and losses

that should be excluded from the restructuring provision.

ILLUSTRATION 13-13
Costs Included/Excluded
from Restructuring Provision

13-28
 Disclosure Related to Provisions

A company must provide a reconciliation of its beginning to

ending balance for each major class of provisions, identifying
what caused the change during the period.

In addition,
► Provision must be described and the expected timing of
any outflows disclosed.
► Disclosure about uncertainties related to expected
outflows as well as expected reimbursements should be
provided.

13-29
 Chapter 13
Current Liabilities, Provisions and
Contingencies
LO3
Contingent Assets and Liabilities
ACCT 220
FALL 2020

13-30
 CONTINGENCIES

Contingent Liabilities
Contingent liabilities are not recognized in the financial
statements because they are
1. A possible obligation (not yet confirmed),

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.

13-31
 Contingent Liabilities

Illustration 13-16 presents the general guidelines for the

accounting and reporting of contingent liabilities.

ILLUSTRATION 13-16
Contingent Liability
Guidelines

13-32
 CONTINGENCIES

Contingent Assets
A contingent asset is a possible asset that arises from past
events and whose existence will be confirmed by the
occurrence or non-occurrence of uncertain future events not
wholly within the control of the company.

Typical contingent assets are: Pending court cases, tax

refunds disputed

Contingent assets are not recognized on the statement of financial position.

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 Contingent Assets

The general rules related to contingent assets are presented

in Illustration 13-18.

ILLUSTRATION 13-18
Contingent Asset Guidelines

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 Chapter 13
Current Liabilities, Provisions and
Contingencies
LO4
Presentation of Liability related
information

ACCT 220
FALL 2020

13-35
 PRESENTATION AND ANALYSIS

Presentation of Current Liabilities

 Usually reported at their full maturity value.
 Difference between present value and the maturity
value is considered immaterial.

13-36
 Presentation of Current Liabilities
Unilever Pakistan Dec 31, 2019

13-37
13-38
 Shell Pakistan Dec 31, 2019

13-39
 Analysis of Current Liabilities

Liquidity regarding a liability is the expected time to elapse

before its payment. Two ratios to help assess liquidity are:

13-40