IAS 37 Provisions, Contingent Liabilities and Contingent Assets

 

Background

IAS 37 defines and specifies the accounting for provisions, contingent liabilities, and contingent assets. It also outlines all relevant disclosures related to provisions, contingent liabilities, and contingent assets.

IAS 37 was issued in September 1998 and applicable for periods start on or after 1 July 1999.

 

Objective

The objective of this Standard 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 notes to enable users to understand their nature, timing and amount.

 

Scope

• ·       This Standard shall be applied by all entities in accounting for provisions, contingent liabilities and contingent assets, except:

(a) those resulting from executory contracts, except where the contract is onerous; and

(b) those covered by another Standard.

 

• ·       This Standard does not apply to financial instruments (including guarantees) that are within the scope of IFRS 9 Financial Instruments.

 

• ·       Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent. This Standard does not apply to executory contracts unless they are onerous.

 

• ·       When another Standard deals with a specific type of provision, contingent liability or contingent asset, an entity applies that Standard instead of this Standard. For example, some types of provisions are addressed in Standards on:

(a) income taxes (see IAS 12 Income Taxes);

(b) leases (see IFRS 16 Leases ). However, this Standard applies to any lease that becomes onerous before the commencement date of the lease as defined in IFRS 16. This Standard also applies to short-term leases and leases for which the underlying asset is of low value accounted for in accordance with paragraph 6 of IFRS 16 and that have become onerous;

(c) employee benefits (see IAS 19 Employee Benefits);

(d) insurance contracts and other contracts within the scope of IFRS 17 Insurance Contracts;

(f) contingent consideration of an acquirer in a business combination (see IFRS 3 Business Combinations); and

(g) revenue from contracts with customers (see IFRS 15 Revenue from Contracts with Customers). However, as IFRS 15  contains no specific requirements to address contracts with customers that are, or have become, onerous, this Standard applies to such cases.

 

• ·       This Standard defines provisions as liabilities of uncertain timing or amount. In some countries the term ‘provision’ is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Standard.

 

• ·       Other Standards specify whether expenditures are treated as assets or as expenses. These issues are not addressed in this Standard. Accordingly, this Standard neither prohibits nor requires capitalisation of the costs recognised when a provision is made.

 

• ·       This Standard applies to provisions for restructurings (including discontinued operations). When a restructuring meets the definition of a discontinued operation, additional disclosures may be required by  IFRS 5 Non‑current Assets Held for Sale and Discontinued Operations.·

 

Key Definitions

Provision

A provision is a liability of uncertain timing or amount.

 

Liability

A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

 

Legal Obligation

A legal obligation is an obligation that derives from:

(a) a contract (through its explicit or implicit terms);

(b) legislation; or

(c) other operation of law.

 

Constructive obligation

A constructive obligation is an obligation that derives from an entity’s actions where:

(a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and

(b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

 

Contingent liability

A contingent liability is:

(a) a possible obligation 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 entity; or

(b) a present obligation that arises from past events but is not recognised because:

(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

(ii) the amount of the obligation cannot be measured with sufficient reliability.

 

Contingent asset

A contingent asset is 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 entity.

 

Onerous Contract

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

 

Present obligation

In rare cases it is not clear whether there is a present obligation. In these cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the end of the reporting period.

 

Past event

A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the case only:

(a) where the settlement of the obligation can be enforced by law; or

(b) in the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation.

 

 

What’s Provisions?

A provision is a liability of uncertain timing or amount. Thus, it can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement.

Accruals are often reported as part of trade and other payables, whereas provisions are reported separately.

 

Relationship between provisions and contingent liabilities

All provisions are contingent because they are uncertain in timing or amount. However, within this Standard the term ‘contingent’ is used for liabilities and assets that are not recognised because their 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 entity.

 

The major difference in provisions and contingent liabilities are: -

• ·       possible obligations, as it has yet to be confirmed whether the entity has a present obligation that could lead to an outflow of resources embodying economic benefits; or
• ·       present obligations that do not meet the recognition criteria in this Standard (because either it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made).

 

Recognition & Measurement under the standard

Recognition of provision

A provision shall be recognised when:

(a) an entity has a present obligation (legal or constructive) as a result of a past event;

(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognised.

 

Recognition of Contingent liabilities

• ·       An entity shall not recognise a contingent liability.
• ·       A contingent liability is disclosed, as required by paragraph 86, unless the possibility of an outflow of resources embodying economic benefits is remote.
• ·       Where an entity is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability. The entity recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made.
• ·       Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in the financial statements of the period in which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be made).

Recognition of Contingent assets

• ·       An entity shall not recognise a contingent asset.
• ·       Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the entity. An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain.
• ·       Contingent assets are not recognised in financial statements since this may result in the recognition of income that may never be realised. However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.
• ·       A contingent asset is disclosed, as required by paragraph 89, where an inflow of economic benefits is probable.
• ·       Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognised in the financial statements of the period in which the change occurs. If an inflow of economic benefits has become probable, an entity discloses the contingent asset (see paragraph 89).

 

Measurement criteria’s:

• o   Best estimate -The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.
• o   Risks and uncertainties - The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision.
• o   Present value - Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation. The discount rate (or rates) shall be a pre‑tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability. The discount rate(s) shall not reflect risks for which future cash flow estimates have been adjusted.
• o   Future events- Future events that may affect the amount required to settle an obligation shall be reflected in the amount of a provision where there is sufficient objective evidence that they will occur.
• o   Expected disposal of assets - Gains from the expected disposal of assets shall not be taken into account in measuring a provision.
• o   Reimbursements - Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognised for the reimbursement shall not exceed the amount of the provision.In the statement of comprehensive income, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.

• o   Changes in provisions - Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision shall be reversed.
• o   Use of provisions - A provision shall be used only for expenditures for which the provision was originally recognised.

 

Application of the recognition and measurement rules

Future operating losses - Provisions shall not be recognised for future operating losses.

Onerous contracts - If an entity has a contract that is onerous, the present obligation under the contract shall be recognised and measured as a provision.

Restructuring - A restructuring is a sale or termination of a line of business closure of business locations changes in management structure fundamental reorganisations.

• ·       A provision for restructuring costs is recognised only when the general recognition criteria for provisions set out in paragraph 14 are met. Paragraphs 72–83 of standard set out how the general recognition criteria apply to restructurings.

 

• ·       Restructuring provisions should be recognised as follows:
• Ø  Sale of operation: recognise a provision only after a binding sale agreement.
• Ø  Closure or reorganisation: recognise a provision only after a detailed formal plan is adopted and has started being implemented, or announced to those affected. A board decision of itself is insufficient.
• Ø  Future operating losses: provisions are not recognised for future operating losses, even in a restructuring.
• Ø  Restructuring provision on acquisition: recognise a provision only if there is an obligation at acquisition date.

 

• ·       Restructuring provisions should include only direct expenditures necessarily entailed by the restructuring, not costs that associated with the ongoing activities of the entity. [IAS 37.80]

 

Disclosure

• Ø  For each class of provision, an entity shall disclose (Comparative information is not required):

(a) the carrying amount at the beginning and end of the period;

(b) additional provisions made in the period, including increases to existing provisions;

(c) amounts used (ie incurred and charged against the provision) during the period;

(d) unused amounts reversed during the period; and

(e) the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate.

 

• Ø  An entity shall disclose the following for each class of provision:

(a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits;

(b) an indication of the uncertainties about the amount or timing of those outflows. Where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events, as addressed in paragraph 48; and

(c) the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.

 

 

You may also refer the standard: -

IAS 16 Property, Plant and Equipment