Question

PART 2 IAS 37 Provisions, contingent liabilities and contingent assets was issued in 1998. Prior to its publication, there was no International Accounting Standard that dealt with the general subject of accounting for provisions.

Mango Limited prepares its financial statements to 31 December each year. During the years ended 31 December 2016 and December 2017, the following events occurred. Mango limited is involved in extracting minerals in a number of different countries. The process typically involves some contamination of the site from which the minerals are extracted. Mango Limited makes good this contamination only where legally required to do so by legislation passed in the relevant country.

The company has been extracting minerals in Copperland for a long time and expects its site to produce output until December 2021. On 23 December 2016, it came to the attention of the directors of Mango Limited that the government of Copperland was 9 virtually certain to pass legislation requiring the making good of mineral extraction sites. The legislation was dully passed on 15 March, 2017. The directors of Mango Limited estimate that the cost of making good the site in Copperland will be N$ 2 Million. The estimate is of the actual cash expenditure that will be incurred on 31 December, 2021.

Required (a) Explain why there was a need for an accounting standard dealing with provisions, and summarise the criteria that need to be satisfied before a provision is recognised (12)

(b) Compute the effect of the estimated cost of making good the site on the financial statements of Mango limited for BOTH of the years ended 31 December 2016 and 2017. Give explanations of the figures you compute (13)

The annual discount rate to be used in any relevant calculation is 10%

The relevant discount factors at 10% are:

Year 4 at 10% 0.683

Year 5 at 10% 0.621

Answer 1

Answer to part A

Need for a standard to deal with provisions can be summed up in following 2 points:

- Considering the periodicity concept, entities need to close their books at periodical intervals. It is not always possible for entities to have complete information regarding all expenses incurred during the period as on the cut off date. Therefore, it was inevitable that entities estimated expenses which were incurred but dcumentation for the same was nto received and record such expenses in their books as provisional expenses, subject to finalisation at a later date in line with the accural concept

- However, this requirement as per accrual concept was often misused by entities, which, in high profit years, had a tendency to recognise costs which did not exist and show normal profits along with a "buffer"on the liabilities side. In years of not so good performance, all these "buffer"amounts which included expenses which were recorded in the previous years but never expected to be paid were reversed from liabilities, thus helping entities smoothen their profits. Therefore, a need was felt for a standard which will outline the prerequites to be satisfied before a provision/liability was recognised in the books of accounts. The standard requires an entity to have a legal or a constructive obligation which will require outflow of resources to settle, in order for a provision/liabiity to be recognised.

Answer to part B:

The company has a legal obligation which is estimted to cost the company 2 mn in 2021. Therefore, this provision/liability of 2 mn will be recorded in the books of accounts as on December 2016 at fair value. As the liability is payable after 5 years, PV factor used will be 0.621. Therefore, a provision of 1.242 mn will be recognised (2,000,000*0.621) as on December 2016. In December 2017, finance cost will be accrued on this liability, leading a finance cost of 0.1242 mn (1.242*10%). This finance cost will be added to the provision. The closing balance of provision will be 1.3662 mn (1.242+0.1242). As the amount is payable in 2012, in both the years, the provision/liability will be presented as a non current liability.

Please comment for any further clarificaitons