CAF-6 · Chapter 1
IAS 10, IAS 37 & IFRIC 1 MCQs with Answers
15 multiple-choice questions on IAS 10, IAS 37 & IFRIC 1 for CAF-6 Corporate Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A company's reporting period ends on 31 December 20X5. On 15 February 20X6, before the financial statements are authorized for issue, a major fire destroys the company's primary storage facility. How should this event be treated in the 20X5 financial statements?
- A) Adjust the financial statements to reflect the loss of the facility.
- B) Disclose the event as a non-adjusting event after the reporting period.
- C) Ignore the event as it happened in the next financial year.
- D) Recognize a provision for the replacement of the storage facility.
Show answer & explanation
Answer: B) Disclose the event as a non-adjusting event after the reporting period.
Since the fire occurred after the year-end, it does not provide evidence of conditions that existed at the end of the reporting period. Therefore, it is a non-adjusting event and its effect should be disclosed if material.
Question 2
Omega Industries causes environmental damage in a country where there is no environmental legislation forcing a cleanup. However, Omega has a widely published internal policy of cleaning up all environmental contamination it causes. According to IAS 37, does an obligation exist?
- A) No obligation exists because there is no legal requirement.
- B) A legal obligation exists due to international law.
- C) A constructive obligation exists because the policy creates a valid expectation.
- D) A contingent liability exists and should only be disclosed.
Show answer & explanation
Answer: C) A constructive obligation exists because the policy creates a valid expectation.
A past event leads to a present obligation (obligating event). Even without legislation, the company's widely published policy creates a valid expectation in other parties, forming a constructive obligation.
Question 3
Delta Ltd faces claims from 20 customers for faulty products. The company estimates that each claim will be settled in the range of Rs. 40,000 to Rs. 60,000 per claim, with each amount in this range being equally likely. What is the best estimate of the provision required?
- A) Rs. 800,000
- B) Rs. 1,000,000
- C) Rs. 1,200,000
- D) Rs. 2,000,000
Show answer & explanation
Answer: B) Rs. 1,000,000
When each outcome in a continuous range is equally likely, the mid-point of the range is used. The mid-point between 40,000 and 60,000 is 50,000. 50,000 x 20 customers = Rs. 1,000,000.
Question 4
Sigma Corp provides a warranty for its products. Based on past experience, there is a 60% chance of zero repair costs, a 30% chance of minor repairs costing Rs. 1,000,000 in total, and a 10% chance of major repairs costing Rs. 2,000,000 in total. What amount should be recognized as a warranty provision?
- A) Rs. 0
- B) Rs. 500,000
- C) Rs. 1,000,000
- D) Rs. 3,000,000
Show answer & explanation
Answer: B) Rs. 500,000
The provision is calculated using the expected value method: (0 x 60%) + (1,000,000 x 30%) + (2,000,000 x 10%) = 0 + 300,000 + 200,000 = Rs. 500,000.
Question 5
Gamma Ltd is being sued for damages of Rs. 5 million, and a provision is recognized for this full amount. Gamma expects to recover Rs. 3 million from a sub-contractor, and this recovery is virtually certain. How should this reimbursement be accounted for in the statement of financial position?
- A) Deduct Rs. 3 million from the provision and show a net liability of Rs. 2 million.
- B) Recognize a separate asset of Rs. 3 million and a provision of Rs. 5 million.
- C) Disclose the Rs. 3 million as a contingent asset only.
- D) Recognize a separate asset of Rs. 5 million.
Show answer & explanation
Answer: B) Recognize a separate asset of Rs. 3 million and a provision of Rs. 5 million.
When reimbursement is virtually certain, it is recognized as a separate asset. The asset recognized cannot exceed the amount of the provision. They should not be netted off in the statement of financial position.
Question 6
Which of the following statements regarding future operating losses is correct according to IAS 37?
- A) A provision must be recognized for expected future operating losses.
- B) Future operating losses can be recognized if they are highly probable.
- C) Provisions shall not be recognized for future operating losses.
- D) Future operating losses are recognized directly in equity.
Show answer & explanation
Answer: C) Provisions shall not be recognized for future operating losses.
IAS 37 specifically states that provisions shall not be recognized for future operating losses because they do not meet the definition of a liability (there is no present obligation arising from past events).
Question 7
Epsilon Ltd has a non-cancellable contract to purchase 500 units of raw material per month for the next 10 months at Rs. 1,000 per unit. Due to a change in the production process, these materials are no longer needed and cannot be resold. What is the provision for this onerous contract?
- A) Rs. 5,000
- B) Rs. 500,000
- C) Rs. 1,000,000
- D) Rs. 5,000,000
Show answer & explanation
Answer: D) Rs. 5,000,000
An onerous contract is one where the unavoidable costs of meeting the obligations exceed the economic benefits. The provision is the total cost: 10 months x 500 units x Rs. 1,000 = Rs. 5,000,000.
Question 8
An entity has a customer who owed Rs. 500,000 at the reporting date of 31 December 20X4. On 20 January 20X5, before the financial statements are authorized for issue, the customer goes bankrupt due to deteriorating financial health over the past year. How should this be treated?
- A) Do nothing as the bankruptcy occurred in the next financial year.
- B) Disclose it as a non-adjusting event.
- C) Adjust the financial statements by writing down the receivable.
- D) Recognize a contingent liability.
Show answer & explanation
Answer: C) Adjust the financial statements by writing down the receivable.
This is an adjusting event because the bankruptcy provides additional evidence of a condition (poor collectability of the debt) that already existed at the end of the reporting period.
Question 9
According to IFRIC 1, if an entity uses the cost model for an asset, how should a decrease in the estimated decommissioning liability due to a change in the discount rate be accounted for?
- A) Recognized immediately in profit or loss.
- B) Deducted from the cost of the related asset.
- C) Recognized in other comprehensive income.
- D) Ignored until the decommissioning actually occurs.
Show answer & explanation
Answer: B) Deducted from the cost of the related asset.
Under the cost model, changes in the existing decommissioning liability (such as changes due to the discount rate) are added to or deducted from the cost of the related asset in the current period.
Question 10
An entity is facing a lawsuit. The entity's legal counsel advises that the probability of losing the case and paying damages is 'possible' but not 'probable'. How should this matter be treated in the financial statements?
- A) Recognize a provision for the estimated damages.
- B) Disclose the matter as a contingent liability.
- C) Disclose the matter as a contingent asset.
- D) Do not disclose anything to avoid admitting guilt.
Show answer & explanation
Answer: B) Disclose the matter as a contingent liability.
If the outflow of economic benefits is possible (but not probable), no provision is recognized. Instead, the matter must be disclosed as a contingent liability unless the probability of an outflow is remote.
Question 11
How frequently should an entity review its recognized provisions according to IAS 37?
- A) Only when the obligating event is completely resolved.
- B) At the end of each reporting period.
- C) Once every three to five years.
- D) Only when management believes the estimate has changed significantly.
Show answer & explanation
Answer: B) At the end of each reporting period.
IAS 37 requires that provisions be reviewed at the end of each reporting period and adjusted to reflect the current best estimate of the expenditure required to settle the present obligation.
Question 12
After the reporting period but before the financial statements are authorized for issue, management decides to completely liquidate the entity. How does this decision affect the preparation of the financial statements?
- A) It is a non-adjusting event requiring disclosure only.
- B) The financial statements should be prepared on a going concern basis with an explanatory note.
- C) The financial statements should not be prepared on a going concern basis.
- D) The financial statements remain unchanged.
Show answer & explanation
Answer: C) The financial statements should not be prepared on a going concern basis.
IAS 10 states that an entity should not prepare its financial statements on a going concern basis if events after the reporting period indicate that the going concern assumption is no longer appropriate.
Question 13
Which of the following describes the key characteristic of an 'obligating event' under IAS 37?
- A) It guarantees future profits for the entity.
- B) It is an event occurring after the reporting period.
- C) It exists independently of an entity's future actions.
- D) It only relates to contracts signed with government authorities.
Show answer & explanation
Answer: C) It exists independently of an entity's future actions.
An obligating event is a past event that leads to a present obligation. It must exist independently of an entity's future actions (i.e., the future conduct of its business).
Question 14
Which of the following is a classic example of a non-adjusting event after the reporting period?
- A) The settlement of a court case that confirms a present obligation existed at year-end.
- B) The discovery of fraud showing financial statements were incorrect.
- C) A major decline in the market value of investments occurring after the reporting period.
- D) Information received indicating an asset was impaired at the end of the reporting period.
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Answer: C) A major decline in the market value of investments occurring after the reporting period.
A decline in market value after the reporting period does not relate to conditions that existed at the reporting date, making it a non-adjusting event. The other options provide evidence of conditions that existed at year-end.
Question 15
When does an obligation to the public at large qualify as a valid obligation for recognizing a provision under IAS 37?
- A) Only if the identity of the specific party owed the obligation is known.
- B) If the entity has created a valid expectation through past practice or published policies.
- C) If the public at large formally sues the entity in court.
- D) Obligations to the public at large can never be recognized as a provision.
Show answer & explanation
Answer: B) If the entity has created a valid expectation through past practice or published policies.
An obligation always involves another party. However, it is not necessary to know the specific identity of the party; an obligation can be owed to the public at large if a valid expectation has been created (a constructive obligation).