Question

Palm Coast Aviation (PCA) company has a private jet costing USD24 million. Tanzania Air regulations required this jet to be overhauled every four years. Coastal aviation company expects an overhaul cost to be USD1.6 million in every four years, based on past experience, and on other similar jets. The company policy has been to create a provision for depreciation of £2 million on a straight-line basis over twelve years and an annual provision of £400,000 to meet the cost of the required overhaul every four years. Questions: 1. Is there a present obligation as a result of a past obligating event? 2.Should provision for cost of overhaul be recognized in the books of accounts?

Answer 1

IAS 37 deals with Provisions, Contingent liabilities and Contingent assets.

As per IAS 37, provision needs to be created if all three conditions are fulfilled

1. present obligation(legal or constructive) has arisen as a result of past event( obligating event)
2. payment is probable
3. amount of liability can be estimated reliably.

an event is an obligating event if it is creating a legal or constructive obligation which needs to be settled.

Answer 1 Yes, there is a present obligation to create this provision as a result of past obligating event of purchasing this private jet.

Answer 2. Provision shall be created in the books as all the three conditions are fulfilled. i.e. there  is present obligation arising out of a past obligating event, the payment is probable as overhaul must be done every 4 years and amount of liability can be estimated reliably which is $1.6million