Question

For each of the following situation, discuss with reason whether the company has to make provision in accordance to MFRS 137: Provisions, contingent liabilities and contingent assets.

i. Entity A operated in the palm oil manufacturing business. Under a new legislation, the entity is required to fit smoke filters to its palm oil mills by 30 June 2016. As at 31 December 2015, Entity A has not fitted the smoke filters. The costs to fit the smoke filters are estimated at RM 4 million. As at 31 December 2016, Entity A still has not fitted the smoke filters and therefore faces a probable fine or penalty by law.

ii. A company operates profitably from a factory that it has leased under an operating lease. Annual lease rentals totaled RM 120000. During the year ended 31 December 2015, the company relocates its operations to a new factory. The lease on the old factory continues for the next four years which is up to 31 December 2018, as it cannot be cancelled and the factory cannot be re-let to another user.

Answer 1

Below is the summary as per Financial Reporting Standard 137 on Provisions, Contingent Liabilities and Contingent Assets

A provision is a liability of uncertain timing or amount.

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

A legal obligation is an obligation that derives from:

· a contract (through its explicit or implicit terms);

· legislation; or

· Other operation of law.

A constructive obligation is an obligation that derives from an entity's actions where:

a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and

b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

A contingent liability is:

1. a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

2. a present obligation that arises from past events but is not recognized because:

a) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

b) The amount of the obligation cannot be measured with sufficient reliability.

i. As Entity A required to fit smoke filters to its palm oil mills by 30 June 2016 under a new legislation but it has not fitted the smoke filters As at 31 December 2016 and hence it does not qualify for contingent liability because:

a) The existence of a possible obligation is already confirmed and it does not depend on the occurrence or non-occurrence of one or more uncertain future events.

b) It is very much probable that an outflow will be required to settle the obligation and

c) The amount of the obligation can also be measured with sufficient reliability

By applying all the above criteria Entity A needs to make a provision of RM 4 million as at 31 December 2016 for probable fine or penalty by law.

ii. In this case also as the company neither cancel the existing operating lease contract which is maturing in 31 December 2018 nor can re-let to another user.

By applying all the criteria same as above the company needs to make a provision for annual lease rentals RM 120000 for the next four years which is up to 31 December 2018