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Objective
The
objective of IAS 37 is to ensure that appropriate recognition criteria =
and
measurement bases are applied to provisions, contingent liabilities and
contingent assets and that sufficient information is disclosed in the n=
otes
to the financial statements to enable users to understand their nature,
timing and amount. The key principle established by the Standard is tha=
t a
provision should be recognised only when th=
ere is
a liability i.e. a present obligation resulting from past events. The
Standard thus aims to ensure that only genuine obligations are dealt wi=
th
in the financial statements - planned future expenditure, even where authorised by the board of directors or equivalent
governing body, is excluded from recognition.
Scope
IAS 37
excludes obligations and contingencies arising from: [IAS 37.1]
- financial instruments
carried at fair value (but IAS 37 does apply to financial instrume=
nts
carried at amortised cost) =
- non-onerous executory contracts
- insurance company poli=
cy
liabilities (but IAS 37 does apply to non-policy-related liabiliti=
es
of an insurance company)
- items covered by anoth=
er
IAS. For example, IAS
11, Construction Contracts, applies to obligations arising und=
er
such contracts; IAS
12, Income Taxes, applies to obligations for current or deferr=
ed
income taxes; IAS
17, Leases, applies to lease obligations; and IAS 19, Employee
Benefits, applies to pension and other employee benefit
obligations.
Key Definitions [IAS 37.10]
Pro=
vision: A liability of
uncertain timing or amount.
Lia=
bility:
- Present obligation as a
result of past events
- Settlement is expected=
to
result in an outflow of resources (payment)
Contingent liability:
- a possible obligation
depending on whether some uncertain future event occurs, or <=
/o:p>
- a present obligation b=
ut
payment is not probable or the amount cannot be measured reliably =
Contingent asset:
- a possible asset that =
arises
from past events, and
- whose existence will be
confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the
enterprise.
Recognition of a Provision
An
enterprise must recognise a provision if, a=
nd
only if: [IAS 37.14]
- a present obligation (=
legal
or constructive) has arisen as a result of a past event (the
obligating event),
- payment is probable ('=
more
likely than not'), and
- the amount can be esti=
mated
reliably.
An obligating event is an event that creates a legal or
constructive obligation and, therefore, results in an enterprise having=
no
realistic alternative but to settle the obligation. [IAS 37.10]
A
constructive obligation arises if past practice creates a valid expecta=
tion
on the part of a third party, for example, a retail store that has a
long-standing policy of allowing customers to return merchandise within,
say, a 30-day period. [IAS 37.10]
A poss=
ible
obligation (a contingent liability) is disclosed but not accrued. Howev=
er,
disclosure is not required if payment is remote. [IAS 37.86]
In rare
cases, for example in a lawsuit, it may not be clear whether an enterpr=
ise
has a present obligation. In those cases, a past event is deemed to give
rise to a present obligation if, taking account of all available eviden=
ce,
it is more likely than not that a present obligation exists at the bala=
nce
sheet date. A provision should be recognised for
that present obligation if the other recognition criteria described abo=
ve
are met. If it is more likely than not that no present obligation exist=
s,
the enterprise should disclose a contingent liability, unless the
possibility of an outflow of resources is remote. [IAS 37.15]
Measurement of Provisions
The am=
ount recognised as a provision should be the best esti=
mate
of the expenditure required to settle the present obligation at the bal=
ance
sheet date, that is, the amount that an enterprise would rationally pay=
to
settle the obligation at the balance sheet date or to transfer it to a
third party. [IAS 37.36] This means:
- Provisions for one-off
events (restructuring, environmental clean-up, settlement of a
lawsuit) are measured at the most likely amount. [IAS 37.40] =
- Provisions for large
populations of events (warranties, customer refunds) are measured =
at a
probability-weighted expected value. [IAS 37.39]
- Both measurements are =
at discounted
present value using a pre-tax discount rate that reflects the curr=
ent
market assessments of the time value of money and the risks specif=
ic
to the liability. [IAS 37.45 and 37.47]
In rea=
ching
its best estimate, the enterprise should take into account the risks and
uncertainties that surround the underlying events. Expected cash outflo=
ws
should be discounted to their present values, where the effect of the t=
ime
value of money is material. [IAS 37.42]
If som=
e or
all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement should be recognised as a reduction of the required provisi=
on
when, and only when, it is virtually certain that reimbursement will be
received if the enterprise settles the obligation. The amount recognised should not exceed the amount of the
provision. [IAS 37.53]
In mea=
suring
a provision consider future events as follows:
- forecast reasonable ch=
anges
in applying existing technology [IAS 37.48]
- ignore possible gains =
on
sale of assets [IAS 37.51]
- consider changes in
legislation only if virtually certain to be enacted [IAS 37.50]
Remeasurem=
ent of Provisions [IAS 37.59]
- Review and adjust prov=
isions
at each balance sheet date
- If outflow no longer
probable, reverse the provision to income.
Some Examples of Provisions
|
Circumstance<=
o:p>
|
Accrue a Prov=
ision?
|
|
Restructuring by sale of an operation<=
/p>
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Accrue a provision only after a binding sale agreement
|
|
Restructuring by closure or reorgan=
isation
|
Accrue a provision only after a detailed formal plan is
adopted and announced publicly. A Board decision is not enough
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|
Warranty
|
Accrue a provision (past event was the sale of defective
goods)
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|
Land contamination
|
Accrue a provision if the company's policy is to clean up
even if there is no legal requirement to do so (past event is the
obligation and public expectation created by the company's policy)
|
|
Customer refunds
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Accrue if the established policy is to give refunds (past
event is the customer's expectation, at time of purchase, that a refu=
nd would
be available)
|
|
Offshore oil rig must be removed and sea bed restored
|
Accrue a provision when installed, and add to the cost of
the asset
|
|
Abandoned leasehold, four years to run=
|
Accrue a provision
|
|
CPA firm must staff training for recent changes in tax l=
aw
|
No provision (there is no obligation to provide the
training)
|
|
A chain of retail stores is self-insured for fire loss
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No provision until a an actual fire (no past event)=
|
|
Self-insured restaurant, people were poisoned, lawsuits =
are
expected but none have been filed yet
|
Accrue a provision (the past event is the injury to
customers)
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|
Major overhaul or repairs
|
No provision (no obligation)
|
|
Onerous (loss-making) contract
|
Accrue a provision
|
Restructurings
A
restructuring is: [IAS 37.70]
- Sal=
e or termination of a l=
ine of
business
- Closure of business
locations
- Changes in management
structure
- Fundamental reorganisation of company =
Restru=
cturing
provisions should be accrued as follows: [IAS 37.72] =
- =
Sale of operation:<=
/b> accrue provision only=
after
a binding sale agreement [IAS 37.78] If the binding sale agreement=
is
after balance sheet date, disclose but do not accrue
- Closure or reorganisation: accrue only after a detailed formal plan=
is
adopted and announced publicly. A board decision is not enough.
- Future operating losse=
s: Provisions should not=
be recognised for future operating losses, even=
in a
restructuring
- Restructuring provisio=
n on
acquisition (merger): Accrue provision for terminating employees,
closing facilities, and eliminating product lines only if announce=
d at
acquisition and, then only if a detailed formal plan is adopted 3
months after acquisition. [IAS 22.31]
Restru=
cturing
provisions should include only direct expenditures caused by the
restructuring, not costs that associated with the ongoing activities of=
the
enterprise. [IAS 37.80]
What Is the Debit Entry?=
When a
provision (liability) is recognised, the de=
bit
entry for a provision is not always an expense. Sometimes the provision=
may
form part of the cost of the asset. Examples: obligation for environmen=
tal
cleanup when a new mine is opened or an offshore oil rig is installed. =
[IAS
37.8]
Use of Provisions
Provis=
ions
should only be used for the purpose for which they were originally recognised. They should be reviewed at each balan=
ce
sheet date and adjusted to reflect the current best estimate. If it is =
no
longer probable that an outflow of resources will be required to settle=
the
obligation, the provision should be reversed. [IAS 37.61]
Contingent Liabilities
Since =
there
is common ground as regards liabilities that are uncertain, IAS 37 also
deals with contingencies. It requires that enterprises should not recognise contingent liabilities - but should dis=
close
them, unless the possibility of an outflow of economic resources is rem=
ote.
[IAS 37.86]
Contingent Assets
Contin=
gent
assets should not be recognised - but shoul=
d be
disclosed where an inflow of economic benefits is probable. When the realisation of income is virtually certain, then =
the
related asset is not a contingent asset and its recognition is appropri=
ate.
[IAS 37.31]
Disclosures
Reconc=
iliation
for each class of provision: [IAS 37.84]
- Opening balance <=
/o:p>
- Additions <=
/span>
- Used (amounts charged
against the provision)
- Released (reversed)
- Unwinding of the disco=
unt
- Closing balance <=
/o:p>
A prior year reconciliation is not required. [IAS 37.84] <=
o:p>
For ea=
ch
class of provision, a brief description of: [IAS 37.85]
&=
nbsp;
- Nature
- Timing
- Uncertainties
- Assumptions
- Reimbursement
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