This standard deals with liabilities and assets whose timing or amount is uncertain.

• Provisions are measured at the best estimate of the expenditure required.
• Contingent Liabilities and Contingent Assets are not recognized but must be disclosed in the financial statements.

Term	Definition	Recognition Criteria	Treatment in Financial Statements
Provision	A liability of uncertain timing or amount.	All three must be met: 1. A present obligation (legal or constructive) from a past event. 2. A probable (>50% chance) outflow of resources. 3. A reliable estimate can be made.		Recognized as a liability on the Statement of Financial Position. An expense is recorded.
Contingent Liability	A possible obligation, or a present obligation that is not probable or cannot be measured reliably.	Does not meet all criteria for a provision.	Not Recognized. It is disclosed in the notes to the financial statements, unless the possibility of outflow is remote.
Contingent Asset	A possible asset arising from past events whose existence will be confirmed by future uncertain events.	Inflow of benefits is possible but not virtually certain.	Not Recognized. It is disclosed in the notes only if the inflow of economic benefits is probable.

Onerous Contracts in Government

An onerous contract arises when the cost of fulfilling a contract exceeds the benefits received. In such cases, a provision must be recognized.

Example:
A government agency signs a contract for the supply of public school textbooks at a fixed price. However, due to inflation, the cost of printing and transportation rises significantly, making the contract loss-making. Since the government is legally bound to fulfill the contract, a provision must be recorded for the expected loss under IPSAS 19.

Restructuring in the Public Sector

Restructuring involves significant changes in government operations or service delivery. A provision is recognized only when there is a formal plan that has been communicated to those affected. The provision includes only unavoidable costs and not those related to ongoing activities.

Types of restructuring in government include:

• Closure of a government department or agency
  • Example: The government decides to dissolve a parastatal and transfer its functions to another ministry. A provision is required for severance pay and contract termination costs.
• Ceasing delivery service in a particular region
  • Example: A county government stops providing free ambulance services due to budget constraints. Provisions may be required for terminating service contracts with suppliers and compensating affected employees.
• Relocating government offices or services
  • Example: A national government ministry relocates from Nairobi to a new headquarters in Nakuru. The provision includes costs for moving office equipment, relocating staff, and terminating existing rental agreements

NB: A provision is recognised if there is a detailed formal plan and the plan has been announced. The provision only includes costs which are necessarily to be incurred and not associated with continuing activities.

Example 1: Provision for Site Restoration (IPSAS 19)

This example shows how to account for a long-term obligation that requires discounting.

On July 1, 2024, a County Government opens a new landfill site. According to environmental laws, the county is legally obligated to decommission and restore the site at the end of its useful life, which is estimated to be 10 years.

• Estimated Future Restoration Cost (in 10 years): Ksh 20,000,000
• Discount Rate: 5% per annum

Step 1: Assess the Recognition Criteria

First, determine if a provision should be recognized.

1. Present Obligation? Yes. The operation of the landfill (the past event) creates a legal obligation to restore the site in the future.
2. Probable Outflow? Yes. It is more likely than not that the county will have to spend money to restore the site.
3. Reliable Estimate? Yes. The future cost has been reliably estimated at Ksh 20,000,000.

Since all three criteria are met, a provision must be recognized.

Step 2: Initial Measurement (Discounting to Present Value)

Because the payment will be made far in the future (10 years), the provision must be recorded at its present value.

• Formula:
  • FV (Future Value) = Ksh 20,000,000
  • r (discount rate) = 5% (or 0.05)
  • n (number of periods) = 10 years
• Calculation:

Journal Entry (July 1, 2024):

• Dr Property, Plant, and Equipment (Landfill Site) Ksh 12,278,265
• Cr Provision for Site Restoration Ksh 12,278,265 (To recognize the present value of the decommissioning liability as part of the asset’s cost)

Step 3: Subsequent Measurement (Unwinding of the Discount)

Each year, the provision’s value must increase to reflect the time value of money. This increase is recognized as a finance cost.

Calculation for the First Year (ended June 30, 2025):

• Finance Cost: Opening Provision Balance × Discount Rate
  • Ksh 12,278,265 × 5% = Ksh 613,913

Journal Entry (at June 30, 2025):

• Dr Finance Cost (Surplus/Deficit) Ksh 613,913
• Cr Provision for Site Restoration Ksh 613,913 (To record the unwinding of the discount for the year)

After this entry, the provision’s closing balance will be Ksh 12,892,178 (12,278,265 + 613,913). This process is repeated each year until the provision equals Ksh 20,000,000 at the end of year 10.

Example 2: Contrasting Case – Contingent Liability

A government ministry is sued for Ksh 10,000,000 for an alleged breach of contract. As of the reporting date, the ministry’s lawyers advise that there is only a 40% chance the ministry will lose the case.

Assessment and Treatment:

1. Present Obligation? Yes, the lawsuit creates a potential legal obligation from a past event.
2. Probable Outflow? No. A 40% chance is considered possible, but not probable (probable means >50%).
3. Reliable Estimate? The amount is known (Ksh 10,000,000).

Since the outflow is not probable, this does not meet the criteria for a provision.

Correct Treatment:

• No liability is recognized on the Statement of Financial Position.
• The situation is disclosed as a Contingent Liability in the notes to the financial statements. The disclosure would describe the nature of the lawsuit, the estimated financial effect (Ksh 10,000,000), and the uncertainty of the outcome.

Example 3

A County Government is facing the following legal issues:

1. A former employee has sued the County for wrongful dismissal, claiming Sh. 20 million. The County’s lawyers have advised that it is probable the County will lose and will have to pay an amount they can reliably estimate at Sh. 12 million.
2. A contractor has sued the County for Sh. 50 million. The case has just begun, and the County’s lawyers advise that the outcome is uncertain and they cannot reliably estimate a potential payment.

Required: In accordance with IPSAS 19, explain the correct accounting treatment for each of the two legal cases in the County’s financial statements for the year. (6 marks)

In accordance with IPSAS 19, the two cases must be treated differently:

• Case 1: Wrongful Dismissal (Sh. 12 million)
  • Treatment: This must be recognised as a Provision.
  • Reasoning: It meets all three criteria for recognition:
    1. There is a present obligation from a past event (the dismissal).
    2. It is probable that an outflow of resources (payment) will be required (based on legal advice).
    3. A reliable estimate (Sh. 12 million) of the obligation can be made.
  • Financial Statement Impact: The County will record an expense of Sh. 12 million in the Statement of Financial Performance and a liability of Sh. 12 million (under “Provisions”) in the Statement of Financial Position.
• Case 2: Contractor Lawsuit (Sh. 50 million)
  • Treatment: This must be treated as a Contingent Liability.
  • Reasoning: It fails the recognition criteria. It is a possible obligation whose outcome is uncertain (not probable), and the amount cannot be reliably estimated.
  • Financial Statement Impact: No liability or expense is recorded. Instead, the County must disclose the nature of this contingent liability (the details of the lawsuit, the uncertainty, and the potential Sh. 50m claim) in the notes to the financial statements.