How to approach it
- Test each matter for a present obligation at the reporting date: legal, or constructive from published policy and past practice.
- Ask whether the expenditure can be avoided by future actions; if so, no obligation.
- Restructuring needs a detailed formal plan and a valid expectation in those affected before year-end.
- If no provision, decide whether disclosure is needed (contingent liability or material non-adjusting event).
Key rules to apply
- IAS 37: a constructive obligation arises from an established pattern of practice or published policy that creates valid expectations.
- No provision for future operating costs or costs avoidable by changing the way the business operates.
- A board decision alone does not create a restructuring obligation.
- IAS 10: material non-adjusting events are disclosed (nature and estimated effect).
Common mistakes
Drawn from the examiners' comments for this sitting (summarised in our words) and from typical errors on this topic.
- Concluding 'no legal requirement, no provision' and missing the constructive obligation (examiners' point).
- Providing for future compliance costs because a law has been enacted.
- Not disclosing a material post-year-end restructuring announcement.
Similar question with worked solution
Written by us with our own numbers; it tests the same skills as Q6 without copying it.
Original practice question
Three provision decisions
(a) A retailer has always refunded unhappy customers within 60 days, beyond its legal duty, and advertises this. (b) A new law requires dust filters by 2027; none are fitted yet and the company has not breached the law at year-end. (c) The board decided in December to relocate a plant; staff and suppliers were told in February.
Required: Provision, disclosure, or neither?
Worked solution
| Matter | Conclusion | Reason |
|---|---|---|
| (a) Refunds | Provision | Constructive obligation from published policy and practice; estimate expected refunds |
| (b) Filters | Neither for the filter cost | Expenditure avoidable by future action; no obligation yet. A penalty provision arises only once a breach occurs |
| (c) Relocation | Disclose as non-adjusting event | No valid expectation created before year-end, so no provision |
Answer: Provide for (a); nothing for (b); disclose (c) if material.