ACCA FR: provisions and events after the reporting period
This outcome tests whether you can decide if a liability exists at the year end and how later events change the numbers. The examiner likes it because one short scenario checks the IAS 37 recognition tests, the IAS 10 cut-off date and the adjusting versus non-adjusting split.
The rule
Recognize a provision when there is a present obligation from a past event, an outflow is probable, and a reliable estimate can be made. IAS 10 covers events between the reporting date and the date the financial statements are authorized for issue, which is the board authorization date, not the date they are sent to shareholders. An adjusting event gives evidence of a condition that existed at the reporting date, so you change the amounts. A non-adjusting event arises from conditions after the reporting date, so you only disclose its nature and estimated financial effect if it is material. Events after the authorization date are outside IAS 10 for those statements.
Worked example
Hyde Co has a year end of 31 December 20X5 and has not yet authorized its statements.
Case 1: A customer was injured in November 20X5. At the year end Hyde recognized a provision of $400,000. On 15 January 20X6 the court settled the case at $420,000. The settlement confirms the obligation that existed at 31 December, so it is an adjusting event.
Adjustment: $420,000 - $400,000 = $20,000 extra provision and expense.
Case 2: On 20 February 20X6 a flood destroyed a warehouse. Flood conditions did not exist at 31 December 20X5, so it is a non-adjusting event. The warehouse stays at its year-end carrying amount. If material, Hyde discloses the nature of the event and an estimate of its financial effect.
Result: provision increased to $420,000; flood disclosed only.
Remember: the test is whether the condition existed at the reporting date, not whether the event was bad news, and the cut-off is the authorization date, not the date the statements reach shareholders.
Where candidates lose marks
Using the date the statements were sent to shareholders as the cut-off instead of the board authorization date.
Adjusting for an event such as a flood that arose after the year end, instead of only disclosing it.
Treating a post year-end court settlement as disclosure only, when it confirms an obligation that existed at the year end.
Reducing a bonus liability for expected leavers when forfeited amounts are redistributed to other staff, so the total obligation does not fall.
Try it: 4 questions
Harbor Co has a year end of 31 December 20X5. Management completed its draft financial statements on 12 February 20X6, and the board authorised them for issue on 25 February 20X6. The financial statements were sent to shareholders on 3 March 20X6.
The following material events occurred after the year end: 1. On 18 February 20X6, Harbor Co settled a lawsuit arising from an incident in September 20X5. The settlement amount provides better evidence of the obligation that existed at 31 December 20X5. 2. On 27 February 20X6, a flood damaged one of Harbor Co's warehouses.
Assume there are no going concern issues. In accordance with IAS 10 Events after the Reporting Period, how should Harbor Co reflect these events in its financial statements for the year ended 31 December 20X5?
Answer: A. IAS 10 covers events between the reporting date and the date the financial statements are authorised for issue, which here is 25 February 20X6. This is the board authorisation date, not the date the statements were sent to shareholders. The 18 February settlement is an adjusting event because it gives evidence of a condition that existed at the year end (IAS 10.9(a)), so the provision is adjusted. The 27 February flood happened after authorisation, so it is outside the scope of IAS 10 for these statements. Disclosing the flood wrongly uses 3 March as the cut-off, disclosing both events wrongly treats the settlement as non-adjusting, and adjusting for the flood ignores both the cut-off and the fact that the flood is not a year-end condition.
On 1 January 20X5, Lark Co introduced a written management bonus scheme, unchanged throughout the year. Under the scheme, a bonus pool equal to 6% of profit before tax for 20X5 is payable to managers. Final 20X5 results fix the pool at $600,000.
Managers must still be employed on 15 March 20X6 to receive payment. The allocation of any manager who leaves before that date is automatically redistributed to managers still employed on that date. After 31 December 20X5, Lark Co cannot cancel or reduce the $600,000 pool.
At 31 December 20X5, Lark Co expects one of its ten eligible managers to resign before 15 March 20X6. Ignore employer social security costs.
How should Lark Co account for the bonus in its financial statements for the year ended 31 December 20X5?
Answer: C. IAS 19 para 19 requires the expected cost of a bonus plan to be recognised when there is a present legal or constructive obligation arising from past events and a reliable estimate can be made. Consistent with the IAS 37 definition of a liability, both conditions are met at 31 December 20X5. Expected leavers reduce the measurement only where their entitlement lapses (IAS 19 para 20). Here, forfeited allocations are redistributed to other managers, so the total obligation remains $600,000 and recording $540,000 is wrong. Deferring recognition to 15 March 20X6 is wrong because the employment condition determines who is paid, not whether Lark Co is obliged to pay the pool.
Hyde Co prepares financial statements for the year ended 31 December 20X5. The financial statements had not been authorised for issue at the dates below. On 15 January 20X6, a court case arising from a customer injury in November 20X5 was settled for $420,000. At 31 December 20X5, Hyde Co had recognised a provision of $400,000 for the case, based on the information then available. On 20 February 20X6, a flood destroyed one of Hyde Co's warehouses. Flood conditions did not exist at 31 December 20X5, and there were no indications of impairment at the year end. Both events are material. How should these events be reported in Hyde Co's financial statements for the year ended 31 December 20X5?
Answer: C. Under IAS 10 Events after the Reporting Period, a court settlement after the year end is an adjusting event because it gives evidence of conditions that existed at the reporting date. The provision is therefore increased to $420,000. The flood arose from conditions that did not exist at 31 December 20X5, so it is a non-adjusting event. Its nature and an estimate of its financial effect are disclosed because it is material. Options A and B wrongly adjust for the flood, and options B and D wrongly treat the settlement as a disclosure-only item.
Ridgeway Co's financial year ended on 31 December 20X1. Its draft financial statements show a trade receivable of $400,000 owed by Harmon Co and a related loss allowance of $10,000. On 20 December 20X1, Harmon Co defaulted on a substantial bank loan, and the bank demanded immediate repayment. The default was reported publicly on 15 January 20X2, and Ridgeway Co first learned of it on 20 January 20X2. Harmon Co entered insolvency proceedings on 15 February 20X2. Ridgeway Co's financial statements are due to be authorised for issue on 10 March 20X2.
How should Ridgeway Co account for the receivable from Harmon Co in its financial statements for the year ended 31 December 20X1?
Answer: A. Under IAS 10, an event after the reporting period is an adjusting event if it provides evidence of conditions that existed at the reporting date. Harmon Co defaulted on 20 December 20X1, so its financial difficulty existed at 31 December 20X1, and the later news and insolvency provide evidence of that condition before the statements are authorised for issue. Ridgeway Co must therefore increase the IFRS 9 loss allowance in the 20X1 financial statements. Disclosure only (option B) would be appropriate only if the condition had arisen after the year end. The date Ridgeway Co learned of the default does not move the loss into 20X2 (option C), and making no adjustment or disclosure (option D) misstates the receivable.
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What is the difference between adjusting and non-adjusting events under IAS 10?
An adjusting event provides evidence of conditions that existed at the reporting date, so the amounts in the financial statements are changed. A non-adjusting event relates to conditions that arose after the reporting date, so it is only disclosed if material.
Which date ends the IAS 10 period?
The period ends on the date the financial statements are authorized for issue, normally when the board approves them. The date they are sent to shareholders does not matter.
When must a company recognize a provision under IAS 37?
A provision is recognized when there is a present legal or constructive obligation from a past event, an outflow of economic benefits is probable, and the amount can be estimated reliably. If any condition is missing, no provision is recognized.