Page 20 - CIMA MCS Workbook February 2019 - Day 2 Suggested Solutions

CIMA FEBRUARY 2019 – MANAGEMENT CASE STUDY

TASK 2 ‐ PROVISIONS

From: Financial Manager
To: Clinical Director
Date: Today

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. For example,
Crowncare has a legal obligation to comply with all legislation that applies to the operation of
dental practices. This could be, for example, ensuring that all health care professionals (not just
dentists) are appropriately qualified and registered with the appropriate professional body and
ensuring that all equipment used complies with meets health and safety requirements. Breach of
a legal obligation may be established, for example, if dental equipment was found to be defective
or not sterilised properly prior to use.

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 Crowncare made public statements regarding
its safety standards or commitment to safety, those statements may form the basis of a
constructive obligation. For example, if Crowncare published adverts claiming that ‘Crowncare
goes the extra mile’ to ensure the highest possible health and hygiene procedures followed,
which may be in excess of statutory or legal requirements, failing to do this may be considered to
be breach of a constructive obligation.

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. In the case of the first claim, it would seem probable that Crowncare
would be required to pay compensation in the region of V$8,000. A provision should be made for
this amount and recognised as an expense in the statement of profit or loss.

In the second case, it is regarded as only possible (rather than probable) that compensation may
be required to be paid to the patient. This is regarded as a contingent liability, and Crowncare
need only disclose the contingent liability in the financial statements, providing details of the
nature of the claim and an estimate of the amount that may be payable should the claim succeed.

In terms of reliable measurement, insurance companies and legal advisors should be able to
quantify the compensation that may be payable in each circumstance as they will have experience
of dealing with similar claims on behalf of other clients.

110 KAPLAN PUBLISHING