ACCA FR · Chapter 8
Provisions, contingencies and events after the reporting period MCQs with Answers
10 multiple-choice questions on Provisions, contingencies and events after the reporting period for ACCA FR Financial Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Snipe Co is suing a supplier for damages. At the year end its lawyers advise that the claim is probably, but not virtually certainly, going to succeed. How should Snipe Co treat the expected inflow?
- A) Recognise an asset and the related income
- B) Make no disclosure until the cash is received
- C) Disclose it as a contingent asset, with no asset recognised
- D) Recognise an asset, with the matching credit to equity
Show answer & explanation
Answer: C) Disclose it as a contingent asset, with no asset recognised
Under IAS 37, contingent assets are never recognised. Where an inflow is probable, the contingent asset is disclosed. Only when the inflow becomes virtually certain is it no longer contingent, and an asset is then recognised.
Question 2
Under IAS 37, which set of conditions must ALL be met before a provision is recognised?
- A) A present obligation (legal or constructive) from a past event, a probable outflow of economic benefits, and a reliable estimate of the amount
- B) A possible obligation from a future event, a probable outflow and board approval
- C) A present obligation from a past event and a possible outflow, whether or not it can be estimated
- D) A board decision to incur the expenditure and an estimate of the amount
Show answer & explanation
Answer: A) A present obligation (legal or constructive) from a past event, a probable outflow of economic benefits, and a reliable estimate of the amount
IAS 37 requires all three conditions: a present obligation, legal or constructive, arising from a past event; an outflow of resources that is probable (more likely than not); and a reliable estimate of the obligation. A board decision alone does not create an obligation, because the entity can still change its mind.
Question 3
On 15 December the board of Grebe Co approved a detailed formal plan to close a factory. The plan was not communicated to employees or customers until 20 January, after the 31 December year end and before the financial statements were authorised. Should a restructuring provision be recognised at 31 December?
- A) Yes, because the board approved a detailed formal plan before the year end
- B) Yes, because announcing the plan in January is an adjusting event
- C) No, because no constructive obligation existed at 31 December
- D) No, because restructuring costs can never be provided for
Show answer & explanation
Answer: C) No, because no constructive obligation existed at 31 December
A constructive obligation to restructure arises only when there is a detailed formal plan and the entity has created a valid expectation in those affected, by starting to implement the plan or announcing its main features. At 31 December no announcement had been made, so there was no obligation. The January announcement is a non-adjusting event and may need to be disclosed.
Question 4
Coot Co has a constructive obligation to restructure a division. Estimated costs are: redundancy payments $800,000, retraining continuing staff $200,000, relocating continuing staff $150,000, penalties for cancelling leases of premises that will be vacated $100,000, and expected future operating losses of the division until closure $300,000. What restructuring provision should be recognised?
- A) $1,250,000
- B) $1,550,000
- C) $800,000
- D) $900,000
Show answer & explanation
Answer: D) $900,000
A restructuring provision includes only direct expenditure that is necessarily caused by the restructuring and not associated with the entity's continuing activities. Redundancy $800,000 + lease cancellation penalties $100,000 = $900,000. Retraining and relocating continuing staff relate to future operations, and future operating losses cannot be provided for.
Question 5
On 1 January Moorhen Co installed an offshore platform. It is legally obliged to dismantle the platform after 10 years at an estimated cost of $5,000,000. The appropriate discount rate is 8%. What provision should be shown at 31 December of the first year? (Use unrounded discount factors and round your final answer to the nearest dollar.)
- A) $2,315,967
- B) $5,000,000
- C) $2,501,244
- D) $2,084,370
Show answer & explanation
Answer: C) $2,501,244
Initial provision = PV of $5,000,000 in 10 years at 8% = $5,000,000 / 1.08^10 = $2,315,967 (unrounded discount factor, rounded to the nearest dollar). The same amount is added to the cost of the platform. The discount unwinds at 8% during year 1: $2,315,967 x 8% = $185,277, charged as a finance cost. Closing provision = $2,315,967 + $185,277 = $2,501,244. The asset part is depreciated separately; depreciation does not reduce the provision.
Question 6
Under IAS 37, how should a contingent liability be treated where an outflow of economic benefits is possible but not probable?
- A) Recognise a provision for the best estimate of the outflow
- B) Ignore it completely
- C) Disclose it in the notes to the financial statements
- D) Recognise it as a reduction in equity
Show answer & explanation
Answer: C) Disclose it in the notes to the financial statements
A contingent liability is not recognised. It is disclosed unless the possibility of an outflow is remote, in which case nothing is reported. A provision is recognised only when the outflow is probable and the amount can be reliably estimated.
Question 7
Dipper Co sold 10,000 products under a one-year warranty during the year. Past experience shows 80% will need no repairs, 15% will need minor repairs costing $50 each and 5% will need major repairs costing $400 each. No claims have yet been made. What warranty provision should be recognised?
- A) $275,000
- B) $200,000
- C) $2,250,000
- D) $800,000
Show answer & explanation
Answer: A) $275,000
For a large population of items, IAS 37 uses the expected value. Expected cost per unit = (15% x $50) + (5% x $400) = $7.50 + $20.00 = $27.50. Provision = 10,000 x $27.50 = $275,000.
Question 8
Which of the following events, occurring after the reporting date but before the financial statements are authorised for issue, is an ADJUSTING event under IAS 10?
- A) A fire destroys a warehouse and the inventory held in it
- B) The company issues new ordinary shares for cash
- C) The directors declare an equity dividend for the year just ended
- D) A major customer that owed money at the year end is declared bankrupt
Show answer & explanation
Answer: D) A major customer that owed money at the year end is declared bankrupt
Adjusting events give evidence of conditions that existed at the reporting date. A customer's bankruptcy confirms that the receivable was impaired at the year end, so the allowance is adjusted. A fire, a share issue and the declaration of a dividend all reflect conditions that arose after the year end. They are non-adjusting, and are disclosed if material.
Question 9
On 15 February the directors of Ruff Co declared a final ordinary dividend of $500,000 for the year ended 31 December. The financial statements are authorised for issue on 10 March. How should the dividend be treated in the financial statements for the year ended 31 December?
- A) It is disclosed in the notes but not recognised as a liability
- B) It is recognised as a current liability and deducted from retained earnings
- C) It is recognised as an expense in profit or loss
- D) It is recognised as a provision under IAS 37
Show answer & explanation
Answer: A) It is disclosed in the notes but not recognised as a liability
IAS 10 states that dividends declared after the reporting period are not a liability at the reporting date, because no obligation existed then. They are disclosed in the notes. Equity dividends are never an expense in profit or loss; when they are recognised, they are deducted from retained earnings.
Question 10
Sora Co has a non-cancellable contract to supply goods. The unavoidable costs of fulfilling the contract are $500,000, and the revenue receivable is $380,000. Sora Co could exit the contract by paying a penalty of $150,000. What provision should be recognised for this onerous contract?
- A) $150,000
- B) $120,000
- C) $500,000
- D) $270,000
Show answer & explanation
Answer: B) $120,000
For an onerous contract, the provision is the unavoidable cost, meaning the lower of the net cost of fulfilling the contract and the cost of exiting it. Net cost of fulfilling = $500,000 - $380,000 = $120,000. Penalty to exit = $150,000. Provision = lower amount = $120,000.