Liabilities, Provisions and Contingencies

Introduction and context

Liabilities are central to advanced financial reporting because they represent claims on an entity’s resources and often involve uncertainty about timing, amount, or even existence. A liability may arise from borrowing, purchasing goods on credit, employee benefits, taxation, litigation, environmental damage, warranties, restructuring, or contractual commitments. The accounting challenge is not merely to identify obligations, but to determine when recognition is justified, how the obligation should be measured, and what information users need when recognition is not appropriate.

This chapter focuses principally on the requirements and reasoning associated with IAS 37 Provisions, Contingent Liabilities and Contingent Assets, read together with the Conceptual Framework, IAS 16, IFRIC 1, IFRS 9, IFRS 16 and other relevant standards. Local legislation and jurisdiction-specific reporting requirements may differ, but the underlying analytical discipline remains broadly applicable.

The fundamental tension is between relevance and reliability. Recognising every possible future outflow would make financial statements excessively conservative and potentially misleading. Recognising only legally enforceable debts would omit economically significant obligations. IAS 37 therefore uses a structured threshold based on a present obligation, a probable outflow of economic resources and reliable estimation.

Learning objectives

By the end of this chapter, the reader should be able to:

1. Distinguish liabilities, provisions, contingent liabilities and contingent assets.
2. Apply the recognition criteria for provisions.
3. Measure provisions using expected value, most-likely-outcome and present-value techniques.
4. Account for decommissioning and restoration obligations.
5. Analyse onerous contracts and restructuring obligations.
6. Evaluate uncertain claims, legal disputes and environmental exposures.
7. Explain disclosure requirements and the ethical risks of biased estimation.
8. Critically assess the effects of uncertainty, probability and discounting on reported performance and financial position.

1. The nature of a liability

Under the Conceptual Framework, a liability is a present obligation of an entity to transfer an economic resource as a result of past events. Three ideas are important:

• Present obligation: the entity has little or no practical ability to avoid the transfer.
• Economic resource: the obligation involves a right that has the potential to produce economic benefits for another party.
• Past event: the obligation results from events that have already occurred.

A liability does not require a signed contract. A legal obligation may arise from legislation, a court order or a contract. A constructive obligation arises from an entity’s actions, established practice, published policy or sufficiently specific current statement that creates a valid expectation in other parties that the entity will accept particular responsibilities.

For example, if an entity has consistently repaired products outside the contractual warranty period and publicly represents that it will continue doing so, customers may reasonably expect repairs. The resulting obligation may be constructive even when no legal claim exists.

A liability should be distinguished from a future operating intention. Management’s intention to refurbish a factory, replace equipment or enter a new market does not itself create a present obligation. An obligation generally arises when the entity has undertaken an action that creates an unavoidable responsibility to another party.

2. Classification of uncertain obligations

The following classification is useful:

The terms “probable” and “possible” must be interpreted consistently with the applicable reporting framework. In IAS 37 practice, “probable” generally means more likely than not. The assessment is not a mechanical substitute for professional judgement: probability must be based on available evidence at the reporting date.

3. Recognition of provisions

A provision is recognised when all three conditions are satisfied:

1. The entity has a present legal or constructive obligation as a result of a past event.
2. An outflow of resources embodying economic benefits is probable.
3. A reliable estimate can be made of the amount of the obligation.

If any condition is absent, a provision is not recognised. The item may instead be disclosed as a contingent liability, or no disclosure may be required if the possibility of an outflow is remote.

3.1 Present obligation and the obligating event

The obligating event is the past event that leaves the entity with no realistic alternative to settling the obligation. The event must be analysed at the reporting date, not with hindsight.

For instance, damage caused by an entity’s operations before year-end may create an obligation to remediate. A plan to cause damage in the future does not. Similarly, an announcement of a proposed closure does not normally create a restructuring provision unless implementation has begun and affected parties have a valid expectation that the plan will be carried out.

A detailed formal plan alone is insufficient. For a restructuring provision, the plan normally needs to identify the business or part of the business concerned, the principal locations, the employees affected, expected expenditure and timing. The entity must also have started implementation or communicated the plan in sufficient detail to those affected.

3.2 Probability of outflow

The probability assessment concerns the likelihood that settlement will require an outflow of economic resources. The assessment includes all available evidence, including legal advice, historical experience, technical reports, settlement patterns and events after the reporting period where they provide evidence of conditions existing at year-end.

A large population of individually small obligations may satisfy the probability criterion when considered collectively. Product warranties illustrate this point. Although any single product may not require repair, experience may show that an aggregate warranty obligation is probable and measurable.

3.3 Reliable estimation

A provision is not rejected merely because its amount is uncertain. In most practical situations, a range of outcomes can be estimated using evidence and professional models. Only in exceptional cases will an obligation be incapable of reliable measurement.

The prohibition on recognising an unreliable amount prevents fabricated precision. It does not permit management to avoid recognition simply because estimation requires judgement.

4. Measurement principles

The amount recognised is the best estimate of the expenditure required to settle the present obligation at the reporting date, or to transfer it to a third party at that date, where that is relevant.

The estimate should reflect:

• risks and uncertainties surrounding the obligation;
• expected future events supported by objective evidence;
• the time value of money when material; and
• the expenditures directly attributable to settling the obligation.

Future operating losses are not provided for because they do not arise from a present obligation at the reporting date. However, expected losses from an onerous contract are provided for because the contract itself creates an unavoidable obligation.

4.1 Single obligation: most likely outcome

When a provision concerns a single obligation, the most likely outcome may be the best estimate. It may nevertheless be necessary to consider other outcomes. For example, a legal claim may most likely be settled for $800,000, but a substantial possibility of a $1.5 million judgment may require evaluation rather than automatic selection of $800,000.

4.2 Large populations: expected value

For a large population of obligations, expected value is often appropriate. The expected value is the probability-weighted average of possible outcomes.

Here, E(X) is the expected amount, pᵢ is the probability of outcome i, and xᵢ is the cash outflow associated with that outcome. The probabilities must sum to 1, and all monetary amounts must be measured on the same basis and in the same currency.

Worked example: warranties. An entity sells 10,000 units. Historical evidence indicates that 2% will require repairs costing $100 each. The expected warranty cost is:

10,000 × 2% × $100 = $20,000

The entity recognises a provision of $20,000, subject to consideration of changes in experience, inflation, and the period over which claims will be settled.

4.3 Present value and discounting

Where the effect of the time value of money is material, the provision is measured at present value. Discounting is particularly relevant for long-term decommissioning, restoration and environmental obligations.

PV is present value, FV is the estimated future cash outflow, r is the appropriate discount rate per period, and n is the number of periods until settlement. The rate should be pre-tax and reflect current market assessments of the time value of money and risks specific to the liability, to the extent those risks are not already reflected in the cash flows.

Worked example: restoration. An entity expects to pay $1,000,000 in five years. Using a 6% annual discount rate:

PV = $1,000,000 ÷ (1.06)⁵ ≈ $747,258

The initial provision is approximately $747,258. The difference between this amount and the eventual settlement amount is recognised over time as the discount unwinds. If the liability is initially recognised at the beginning of the period, the first year’s finance cost is approximately:

$747,258 × 6% ≈ $44,835

The calculation assumes annual compounding, a constant discount rate, and settlement exactly five years after initial recognition. In practice, cash-flow timing, inflation and risk adjustments require more sophisticated models.

Discounting is not a device for reducing a liability arbitrarily. A lower present value must reflect a defensible time horizon and market-consistent assumptions.

4.4 Risk and uncertainty

Risk may be reflected either in probability-weighted cash flows or in the discount rate, but it must not be double-counted. If cash flows have already been adjusted for risk, the discount rate should not again include the same risk premium.

Management should document:

• the range of possible outcomes;
• the probability assigned to each outcome;
• the source of probabilities;
• expected inflation and cost escalation;
• the settlement date;
• the discount rate and its components; and
• sensitivity to reasonably possible changes.

5. Reassessment and use of provisions

Provisions are reviewed at every reporting date and adjusted to reflect the current best estimate. If an outflow is no longer probable, the provision is reversed. A provision may be used only for expenditures for which it was originally recognised; it should not become a general reserve for unrelated future costs.

A provision is not recognised for expenditure that will be incurred independently of the event creating the original obligation. For example, a provision for a factory closure cannot be used to absorb later training costs unless those costs formed part of the original obligation and satisfy the recognition criteria.

6. Specific applications

6.1 Onerous contracts

An onerous contract is one in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received. The unavoidable costs are the lower of:

• the costs of fulfilling the contract; and
• any compensation or penalties arising from failure to fulfil it.

The provision reflects the present obligation under the contract. Before recognising an onerous-contract provision, the entity considers impairment of assets dedicated to the contract under the relevant standard.

Following amendments to IAS 37, costs of fulfilling a contract include costs that relate directly to the contract. These may include incremental costs, such as direct labour and materials, and an allocation of other costs directly related to fulfilling contracts, such as depreciation of equipment used for the contract.

Illustrative example. A company must deliver goods for $900,000 but expects direct and allocated fulfilment costs of $1,050,000. The unavoidable loss is $150,000, assuming no termination penalty produces a lower loss. A provision of $150,000 is recognised, subject to any required asset impairment and discounting.

6.2 Restructuring

A restructuring provision includes only direct expenditures arising from the restructuring that are:

• necessarily entailed by the restructuring; and
• not associated with continuing activities.

Examples may include employee termination costs and contract cancellation penalties. Costs of retraining, relocating continuing employees, marketing, new systems and future operating losses are generally not included because they relate to future operations rather than the present obligation.

The accounting depends on the facts at the reporting date. A board decision without communication or implementation may demonstrate intention but not create a constructive obligation.

6.3 Decommissioning and restoration obligations

Mining, energy, manufacturing and infrastructure entities may be required to dismantle assets and restore sites. If the obligation arises when an asset is constructed or used, the initial estimate is generally recognised as part of the cost of the related property, plant and equipment, with a corresponding provision.

The accounting pattern is:

• debit the asset for the initial discounted restoration cost;
• credit the provision for the same amount;
• depreciate the capitalised restoration cost over the asset’s useful life; and
• subsequently remeasure the provision when estimates, timing or discount rates change, applying IFRIC 1 and the relevant accounting policy.

The provision is not an optional reserve. It represents an obligation arising from past use or construction of the asset. Changes in the liability may affect the related asset while the asset is still held, subject to the applicable standard; the unwinding of discount is generally recognised in profit or loss as a finance cost.

Illustrative example. A wind-farm operator constructs equipment costing $20 million. The present value of a legally required dismantling obligation is $2 million. Initial accounting includes equipment of $22 million and a restoration provision of $2 million, before considering other costs. If the equipment has a 20-year useful life and no residual value, straight-line depreciation attributable to the restoration component is $100,000 per year, assuming the capitalised amount remains unchanged.

6.4 Legal claims and uncertain tax or regulatory matters

A legal claim requires analysis of:

• the event giving rise to the claim;
• the strength of the claimant’s case;
• the entity’s legal and constructive obligations;
• the probability of losing or settling;
• likely damages, penalties and legal costs; and
• evidence available at the reporting date.

If an outflow is probable and measurable, a provision is recognised. If the outflow is possible but not probable, a contingent liability is disclosed unless the possibility is remote. Legal advice is important but not conclusive: management and auditors must evaluate the full evidence and avoid treating an optimistic legal opinion as proof that no obligation exists.

Tax disputes may involve uncertain interpretation of law. Depending on the applicable standard, uncertain tax treatments may be addressed under IAS 12 rather than IAS 37. The correct standard must be identified before measurement begins.

7. Contingent liabilities

A contingent liability is either:

1. a possible obligation arising from past events whose existence will be confirmed by uncertain future events not wholly within the entity’s control; or
2. a present obligation that is not recognised because an outflow is not probable or the amount cannot be measured reliably.

Contingent liabilities are not recognised because recognition would imply a level of certainty not supported by the evidence. They are disclosed unless the possibility of an outflow is remote. Disclosure normally describes the nature of the matter, an estimate of its financial effect where practicable, uncertainties about amount or timing, and any possibility of reimbursement.

A contingent liability can become a provision as new evidence changes the probability assessment. The transition is not a correction of the earlier accounting if the earlier assessment was reasonable at that time.

8. Contingent assets

A contingent asset is a possible asset arising from past events whose existence will be confirmed by uncertain future events not wholly within the entity’s control. Examples include a potential insurance recovery, a claim against a supplier, or a favourable court judgment not yet final.

Contingent assets are treated cautiously because recognising uncertain gains can overstate performance and assets. They are not recognised. If an inflow of economic benefits is probable, the nature and expected financial effect are disclosed where practicable. If the inflow becomes virtually certain, the asset is no longer contingent and is recognised in accordance with the relevant standard.

The asymmetry between probable outflows and probable inflows reflects prudence and the risk of recognising gains before they are sufficiently certain. Prudence does not justify systematically overstating provisions or understating assets; estimates must remain neutral and evidence-based.

9. Reimbursements and insurance recoveries

Where another party is expected to reimburse some or all of the expenditure required to settle a provision, the reimbursement is recognised as a separate asset only when receipt is virtually certain if the entity settles the obligation. The reimbursement asset cannot exceed the provision.

The expense relating to a provision may be presented net of the reimbursement in profit or loss when permitted, but the liability and reimbursement asset are normally presented separately unless offsetting criteria are satisfied.

For example, if a recognised environmental provision is $2 million and a legally enforceable insurance recovery of $1.5 million is virtually certain upon settlement, a $2 million liability and a separate $1.5 million asset are recognised. The net expense is $500,000, subject to presentation requirements.

10. Disclosure and communication of uncertainty

Users need more than a closing balance. For each class of provision, disclosures generally include:

• the carrying amount at the beginning and end of the period;
• additions and amounts used;
• unused amounts reversed;
• increases from discount unwinding and changes in discount rates;
• the nature of the obligation;
• expected timing of outflows;
• uncertainties about amount or timing; and
• major assumptions and expected reimbursements.

Disclosure may be omitted in extremely rare cases if it would seriously prejudice the entity’s position in a dispute. Even then, the entity generally indicates the general nature of the dispute and explains why detailed information has not been provided.

Good disclosure distinguishes estimation uncertainty from outcome uncertainty. A provision may be measured reliably while the exact settlement date remains uncertain. Conversely, an apparently precise amount may be highly sensitive to unsupported assumptions.

11. Governance, ethics and audit implications

Provisions are susceptible to earnings management because changes in probability, timing, discount rates and expected costs can materially affect profit. Ethical risks include deliberately delaying recognition, creating excessive “big bath” provisions, using unsupported probabilities, manipulating settlement dates, and netting assets against liabilities to obscure exposure.

Effective governance includes:

• a formal provisions policy;
• documented approval of significant assumptions;
• independent legal and technical evidence;
• regular roll-forward reconciliations;
• sensitivity analysis;
• board or audit committee review of material matters; and
• clear separation between operational optimism and financial reporting evidence.

Auditors typically test the completeness of obligations as well as the accuracy of recorded provisions. Procedures may include reviewing board minutes, legal correspondence, post-year-end payments, contracts, insurance policies, environmental reports and historical claim patterns. The audit challenge is often understatement rather than calculation error.

12. Technology, data and contemporary developments

Modern entities increasingly use data analytics, contract repositories and machine-learning tools to identify obligations. Automated systems can scan contracts for termination penalties, restoration clauses, service-level commitments and warranty language. Statistical models can improve expected-value estimates for high-volume claims.

However, technology does not replace professional judgement. A model may reproduce historical bias, fail to detect a newly enacted regulation, or assign inappropriate probabilities to unprecedented events. Governance should therefore require explainable assumptions, version control, validation, human review and an audit trail.

Climate transition and environmental regulation are creating new estimation challenges. A company may face restoration, remediation or regulatory obligations whose amount and timing depend on evolving law and technology. Climate-related risks do not automatically create provisions: there must still be a present obligation at the reporting date. Nevertheless, climate assumptions may affect useful lives, impairment, expected costs and the probability assessment for existing obligations.

13. Illustrative integrated case

Background

Northstar Energy plc operates an offshore platform. At 31 December 20X5, it has three uncertain matters:

• a statutory obligation to dismantle the platform in 10 years, estimated at $12 million in future cash terms;
• a customer lawsuit arising from a spill, with legal advisers assessing a 60% probability of settlement for $4 million and a 40% probability of no payment; and
• a signed supply contract under which fulfilment costs exceed expected revenue by $900,000. Cancellation would cost $700,000.

The appropriate pre-tax discount rate for the decommissioning obligation is 5% per year. Assume annual compounding and that no relevant risks are double-counted.

Analysis

The decommissioning obligation is a present legal obligation arising from the platform’s construction and operation. The future outflow is probable and measurable. Its present value is:

PV = $12,000,000 ÷ (1.05)¹⁰ ≈ $7,365,566

Northstar recognises a provision of approximately $7.366 million and capitalises a corresponding amount in the platform’s asset cost, subject to the applicable standards. Subsequent depreciation and discount unwinding are recognised over time.

The lawsuit involves a probable outflow because the probability of payment is 60%. The expected amount, using the stated outcomes, is:

(60% × $4,000,000) + (40% × $0) = $2,400,000

Because this is a single legal claim, the most likely outcome may also be relevant. The entity must assess whether $4 million or another settlement amount is the best estimate, rather than automatically using expected value. On the facts supplied, $2.4 million is a defensible probability-weighted estimate, but legal evidence and the likely settlement process must be considered. Assume, for this illustration, that $2.4 million is the best estimate.

The supply contract is onerous. Fulfilment costs are $900,000 above expected revenue, while cancellation costs are $700,000. The unavoidable cost is the lower amount, so Northstar recognises a $700,000 provision, after considering any impairment of assets used for the contract.

Outcome

The recognised provisions, before any later reassessment, are approximately:

The notes should explain the nature, expected timing and estimation uncertainty of each matter. The decommissioning estimate is particularly sensitive to future costs, timing, regulation and discount rates. The legal claim should disclose the uncertainty surrounding the outcome without prejudicing the entity’s position.

Learning points

The case demonstrates that recognition depends on the nature of the obligation, not merely the presence of uncertainty. Discounting applies to long-term obligations; probability-weighting is useful for populations or multiple outcomes; and an onerous contract is measured by the lower unavoidable loss, not simply by the cost of fulfilment.

14. Limitations and critical evaluation

IAS 37 improves consistency but cannot eliminate judgement. Probability thresholds may be applied differently across jurisdictions. Legal systems vary in the meaning of constructive obligation. Long-term provisions may be highly sensitive to discount rates, inflation, technological change and regulatory policy. Expected-value methods can also produce misleading results when outcomes are not independent or when probabilities are based on sparse data.

A further limitation is that disclosure may be too general to support valuation. Excessive aggregation can conceal the difference between a near-certain short-term payment and a remote, highly uncertain litigation exposure. Conversely, excessive detail may prejudice legal negotiations or reveal commercially sensitive information.

Professional users should therefore read provisions alongside cash-flow forecasts, impairment assumptions, risk disclosures, legal reports and post-reporting-date settlements. The reported number is an estimate, not a guaranteed future payment.

Best-practice checklist

Before finalising a provision, the accountant should ask:

1. What past event created the obligation?
2. Is the obligation legal or constructive?
3. Can the entity realistically avoid settlement?
4. Is an outflow probable?
5. What evidence supports the probability assessment?
6. Is the estimate based on the most appropriate method?
7. Are risks reflected once rather than twice?
8. Is discounting material and properly supported?
9. Have related assets, reimbursements and impairment been considered?
10. Does the disclosure explain timing, uncertainty and sensitivity clearly?
11. Has the provision been reassessed at the reporting date?
12. Could management bias or an ethical conflict have affected the estimate?

Chapter Summary

A provision is a recognised liability involving uncertainty about timing or amount. Recognition requires a present legal or constructive obligation from a past event, a probable outflow of economic resources and a reliable estimate. Measurement uses the best estimate of settlement expenditure, with probability-weighted expected values often appropriate for large populations and the most likely outcome often relevant to a single obligation. Material long-term obligations are discounted to present value, and assumptions must avoid double-counting risk.

Onerous contracts create provisions for unavoidable losses, measured using the lower of fulfilment costs and termination or compensation costs. Restructuring provisions are restricted to direct expenditures necessarily entailed by the restructuring. Decommissioning obligations generally create both a provision and a corresponding increase in the cost of the related asset. Contingent liabilities are disclosed rather than recognised unless the outflow becomes probable and measurable. Contingent assets are not recognised until the inflow is virtually certain.

High-quality reporting requires evidence-based estimates, regular reassessment, transparent disclosures, governance oversight and ethical resistance to earnings management. Technology can improve identification and estimation, but it cannot replace professional judgement or accountability.

Key Terms

Liability: A present obligation to transfer an economic resource as a result of past events.

Provision: A recognised liability of uncertain timing or amount.

Present obligation: An obligation existing at the reporting date that the entity has little or no realistic ability to avoid.

Legal obligation: An obligation arising from legislation, contract or another source of law.

Constructive obligation: An obligation created by established practice, policy or sufficiently specific communication that creates a valid expectation.

Obligating event: The past event that creates an unavoidable present obligation.

Contingent liability: A possible obligation, or an unrecognised present obligation, dependent on uncertain future events or lacking recognition conditions.

Contingent asset: A possible asset arising from past events whose existence depends on uncertain future events.

Best estimate: The amount an entity would rationally pay to settle or transfer an obligation at the reporting date.

Expected value: A probability-weighted average of possible outcomes.

Present value: The current value of a future cash flow after discounting.

Discount rate: A rate reflecting the time value of money and relevant risks not already included in cash flows.

Onerous contract: A contract in which unavoidable costs exceed expected economic benefits.

Restructuring provision: A provision for direct costs necessarily arising from a sufficiently committed restructuring.

Decommissioning obligation: An obligation to dismantle, remove or restore an asset or site.

Reimbursement asset: A separate asset recognised when recovery of provision-related expenditure is virtually certain.

Probability assessment: Evaluation of the likelihood of an economic outflow or inflow using available evidence.

Constructive expectation: A reasonable expectation by affected parties that an entity will accept responsibility because of its conduct or communication.

Unwinding of discount: The periodic increase in a discounted liability as settlement approaches.

Estimation uncertainty: Uncertainty arising because an amount or timing must be inferred rather than directly observed.

Review Questions

Short Answer Questions

1. What three conditions must be met before a provision is recognised?
2. Distinguish a legal obligation from a constructive obligation.
3. Why are contingent assets not recognised when an inflow is merely probable?
4. What is meant by an onerous contract?
5. When is discounting applied to a provision?

Long Answer Questions

1. Explain the recognition and measurement principles for provisions under IAS 37, including the role of probability and reliable estimation.
2. Discuss the accounting treatment of decommissioning obligations from initial recognition through subsequent measurement.
3. Compare provisions and contingent liabilities, explaining how changes in evidence can cause an item to move from one category to the other.
4. Explain the requirements for recognising a restructuring provision and identify costs that should normally be excluded.
5. Critically evaluate the ethical and governance risks associated with provisions and uncertain claims.

Analytical / Application Questions

1. An entity expects to pay $5 million in six years to restore a site. The appropriate annual discount rate is 4%. Calculate the initial provision using PV = FV ÷ (1 + r)ⁿ, and explain two assumptions that could materially change the result.
2. A company has 50,000 warranty contracts. Historical evidence indicates a 3% claim rate, with an average repair cost of $180. Calculate the expected warranty provision and explain why an expected-value approach is appropriate.
3. A company faces a lawsuit with a 40% probability of paying $2 million and a 60% probability of paying nothing. Analyse whether recognition is appropriate, identify a defensible measurement approach, and explain what additional evidence should be obtained before finalising the accounts.

Multiple Choice Questions with Answers

Question 1

Which condition is NOT required for recognition of a provision?

A. A present legal or constructive obligation exists.

B. An outflow of resources is probable.

C. The amount can be reliably estimated.

D. The exact settlement date and amount are known with certainty.

Correct Answer: D. The exact settlement date and amount are known with certainty.

Question 2

A company expects 2% of 10,000 products to require repairs costing $100 each. What is the expected warranty provision?

A. $2,000

B. $20,000

C. $200,000

D. $1,000,000

Correct Answer: B. $20,000

Question 3

Which item is normally disclosed but not recognised when an outflow is possible but not probable?

A. Provision

B. Ordinary trade payable

C. Contingent liability

D. Contingent asset

Correct Answer: C. Contingent liability

Question 4

An entity will pay $1,000,000 in five years. At a 6% annual discount rate, the approximate present value is:

A. $747,258

B. $800,000

C. $943,396

D. $1,060,000

Correct Answer: A. $747,258

Question 5

When does a contingent asset become recognised as an asset?

A. When an inflow is merely possible.

B. When an inflow is probable.

C. When the inflow is virtually certain.

D. When management intends to recognise it.

Correct Answer: C. When the inflow is virtually certain.

Question 6

For an onerous contract, the unavoidable cost is generally measured as:

A. The higher of fulfilment cost and cancellation cost.

B. The lower of fulfilment cost and cancellation or compensation cost.

C. Expected revenue less total assets.

D. The contract’s original price only.

Correct Answer: B. The lower of fulfilment cost and cancellation or compensation cost.

Question 7

Which cost is generally included in a restructuring provision?

A. Future marketing expenditure.

B. Training costs for continuing employees.

C. Direct employee termination costs necessarily arising from the restructuring.

D. Future operating losses.

Correct Answer: C. Direct employee termination costs necessarily arising from the restructuring.

Question 8

A decommissioning obligation initially recognised with a related asset is subsequently affected by:

A. Depreciation of the capitalised amount and unwinding of the discount.

B. Revenue recognition only.

C. Inventory turnover only.

D. No subsequent accounting until settlement.

Correct Answer: A. Depreciation of the capitalised amount and unwinding of the discount.

Question 9

What is the principal danger of reflecting the same risk in both cash flows and the discount rate?

A. Understatement of the provision.

B. Double-counting risk and overstating the provision.

C. Automatic recognition of a contingent asset.

D. Elimination of the liability.

Correct Answer: B. Double-counting risk and overstating the provision.

Question 10

Which statement best describes a constructive obligation?

A. A possible future intention with no external communication.

B. An obligation arising only from a bank loan.

C. An obligation created by established practice or communication that creates a valid expectation.

D. A liability that can never be estimated.

Correct Answer: C. An obligation created by established practice or communication that creates a valid expectation.