Page 19 - CIMA May 18 - MCS Day 2 Suggested Solutions

CIMA MAY 2018 – MANAGEMENT CASE STUDY

TASK 2 – PROVISIONS
From: Financial Manager
To: CFO
Date: Today
Subject: Accounting for provisions

Provisions
IAS 37 Provisions, Contingent Liabilities and Contingent Assets (IAS 37) specify three criteria for
recognition of a provision in financial statements as follows:

 there must be a present obligation (legal or constructive) arising from a past transaction or
event.
 It is probable that there will be a future transfer or outflow of economic benefits, and
 It can be measured reliably.
A legal obligation may arise from operation of law or the terms of a contract. Menta has a legal
obligation to comply with all legislation that applies to the operation of its bus services. This could
be, for example, ensuring that all drivers have the appropriate training and licences to perform
their work and ensuring that all buses meet legal requirements for insurance, safety and
mechanical standards. Although there is a legal obligation that all vehicles should be roadworthy,
there is no legal requirement for all buses to be fitted with passenger safety belts. Therefore,
Menta has no legal obligation to fit seatbelts in buses. Menta could not face criminal or civil
action solely for not having seatbelts fitted to all buses.

Breach of a legal obligation may be established, for example, if a bus was determined not to be
roadworthy, or it was not adequately insured.

A constructive obligation arises when third parties have a valid expectation that it will be able to
rely upon the statements and behaviour of another party, such that an obligation is created and
should be recognised in the financial statements. If Menta has made public statements regarding
its safety standards or commitment to safety, they may form the basis of a constructive
obligation. For example, if Menta had published adverts claiming that ‘Menta goes the extra mile’
to ensure the safety of its passengers, then not having seatbelts in all buses (particularly school
buses) may be considered to be breach of a constructive obligation.

Similarly, if Menta had secured the school bus contract by making statements regarding the safety
and suitability of its buses for school children, this may give rise to a constructive obligation if the
children are not adequately supervised or seated safely whilst travelling to and from school.

It must also be established that there will be a probable outflow of economic benefits. An event is
regarded as probable if it is more likely than not to occur. If a legal or constructive obligation is
established, the probable outflow of economic benefits will derive from the consequences of
breach of the obligation. For example, if the bus involved in the accident was deemed not to be
roadworthy following investigation by government inspectors, this may result in liability to pay
fines. If it was established that the driver was driving carelessly or dangerously, this may result in
Menta having liability for the actions of the driver, in addition to the driver potentially facing
criminal prosecution.

106 KAPLAN PUBLISHING