ACCA FA · Chapter 8
Payables, provisions and contingencies (IAS 37) MCQs with Answers
10 multiple-choice questions on Payables, provisions and contingencies (IAS 37) for ACCA FA Financial Accounting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, which set of conditions must ALL be met before a provision is recognised?
- A) A present obligation from a past event, a probable outflow of economic benefits, and a reliable estimate of the amount
- B) A board decision to incur the cost, a probable outflow, and a reliable estimate
- C) A possible obligation, a remote outflow of economic benefits, and an approximate estimate
- D) A future event, a certain outflow, and an exact amount
Show answer & explanation
Answer: A) A present obligation from a past event, a probable outflow of economic benefits, and a reliable estimate of the amount
IAS 37 requires three conditions: a present obligation (legal or constructive) as a result of a past event, a probable outflow of resources embodying economic benefits, and a reliable estimate of the obligation. A board decision alone does not create an obligation, and absolute certainty is not required.
Question 2
A customer has started legal action against a company. The company's lawyers advise that it is possible, but not probable, that the company will lose the case and pay damages of about $90,000. How should this be treated in the financial statements?
- A) Recognise a provision of $45,000
- B) Recognise a provision of $90,000
- C) Make no recognition or disclosure
- D) Disclose a contingent liability in the notes
Show answer & explanation
Answer: D) Disclose a contingent liability in the notes
Where an outflow is possible but not probable, there is no provision. Instead, a contingent liability is disclosed in the notes, describing the nature of the claim and an estimate of its financial effect. No disclosure is needed only if the possibility of an outflow is remote.
Question 3
A company is suing a supplier for damages. Its lawyers believe it is probable, but not virtually certain, that the company will win and receive $50,000. How should this be treated?
- A) Make no recognition or disclosure
- B) Disclose a contingent asset in the notes
- C) Recognise an asset of $50,000
- D) Recognise income of $50,000 and a receivable
Show answer & explanation
Answer: B) Disclose a contingent asset in the notes
Contingent assets are never recognised unless the inflow is virtually certain, in which case the asset is no longer contingent. Where an inflow is probable, the contingent asset is disclosed in the notes. If an inflow were merely possible, no disclosure would be made.
Question 4
A company sold 10,000 units with a one-year warranty. Past experience shows that 80% of units will need no repairs, 15% will need minor repairs costing $20 per unit, and 5% will need major repairs costing $150 per unit. What warranty provision should be recognised?
- A) $105,000
- B) $30,000
- C) $170,000
- D) $75,000
Show answer & explanation
Answer: A) $105,000
For a large population of items the provision is measured using expected values. Expected cost per unit = (80% x $0) + (15% x $20) + (5% x $150) = $0 + $3 + $7.50 = $10.50. Provision = 10,000 x $10.50 = $105,000. Applying a simple average repair cost of ($20 + $150) / 2 = $85 to the 20% needing repair (2,000 x $85) gives $170,000, which ignores the different probabilities. Taking only the minor repairs gives $30,000 and only the major repairs gives $75,000.
Question 5
A provision for warranty costs had a balance of $24,000 at the start of the year. At the year end the required provision is $19,500. What is the effect on profit for the year?
- A) Profit decreases by $4,500
- B) Profit increases by $19,500
- C) Profit decreases by $19,500
- D) Profit increases by $4,500
Show answer & explanation
Answer: D) Profit increases by $4,500
Only the movement in the provision passes through profit or loss. The provision decreases by $24,000 - $19,500 = $4,500, so the provision is debited and profit or loss credited with $4,500, increasing profit.
Question 6
Which of the following should be recognised as a provision at the reporting date?
- A) Expected future operating losses of a loss-making division
- B) The cost of staff training planned for next year
- C) Costs of repairing goods sold in the year under a legally binding warranty
- D) The cost of a head office refurbishment approved by the board but not yet started
Show answer & explanation
Answer: C) Costs of repairing goods sold in the year under a legally binding warranty
A warranty given on goods already sold creates a present legal obligation from a past event (the sale), so a provision is recognised. IAS 37 prohibits provisions for future operating losses. Planned training and refurbishment relate to future actions that the company can still avoid, so there is no present obligation.
Question 7
A business provides the following information about trade payables for the year: Opening balance $31,200 Credit purchases $214,000 Cash paid to suppliers $205,600 Discounts received $2,400 Purchase returns $3,800 Contra with receivables ledger $1,500 What is the closing balance on the payables control account?
- A) $34,300
- B) $31,900
- C) $33,400
- D) $28,900
Show answer & explanation
Answer: B) $31,900
Closing payables = $31,200 + $214,000 - $205,600 - $2,400 - $3,800 - $1,500 = $31,900. All of the payments, discounts, returns and the contra reduce the amount owed. Omitting the contra gives $33,400 and omitting the discounts gives $34,300.
Question 8
On 20 December a company's board decided to close a factory in the following March. At the year end of 31 December, no detailed plan had been drawn up and the decision had not been communicated to employees, customers or suppliers. How should the closure costs be treated in the financial statements for the year ended 31 December?
- A) The costs should be accrued as a current liability
- B) A provision should be recognised, because the board has made the decision
- C) No provision should be recognised, because there is no present obligation at the year end
- D) A provision should be recognised for the closure costs and future operating losses of the factory
Show answer & explanation
Answer: C) No provision should be recognised, because there is no present obligation at the year end
A restructuring provision requires a constructive obligation, which arises only when there is a detailed formal plan and those affected have a valid expectation that it will be carried out (for example, because it has been announced). A board decision alone, not communicated, does not create an obligation. Future operating losses are never provided for.
Question 9
Under IAS 37, what is the required treatment of a contingent liability where the possibility of an outflow of economic benefits is remote?
- A) Disclose in the notes
- B) No recognition and no disclosure
- C) Recognise a provision
- D) Recognise a provision and disclose in the notes
Show answer & explanation
Answer: B) No recognition and no disclosure
If the possibility of an outflow is remote, IAS 37 requires neither a provision nor disclosure. Disclosure is required where an outflow is possible, and a provision where it is probable and can be reliably estimated.
Question 10
A company is defending one legal claim brought by a single customer. This is a single obligation, not a large population of similar items. Its lawyers advise that the company will probably have to pay damages, and estimate a 60% chance that it will pay $400,000 and a 40% chance that it will pay $100,000. Under IAS 37, at what amount should the provision be measured?
- A) $280,000
- B) $500,000
- C) $100,000
- D) $400,000
Show answer & explanation
Answer: D) $400,000
For a single obligation, IAS 37 states that the individual most likely outcome is usually the best estimate. The most likely outcome is paying $400,000 (60% probability), so the provision is $400,000. The expected value of $280,000 ((60% x $400,000) + (40% x $100,000)) is the method for a large population of items, such as warranties, not a single claim. $500,000 adds both outcomes together, and $100,000 is the less likely outcome.