1 Provisions, contingent assets and contingent liabilities â€“ IAS 37 Week 5...
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1 Provisions, contingent assets and contingent liabilities IAS 37 Week 5 MN20018 Slide 2 2 Off Balance Sheet Financing Substance over Form Substance Has a transaction occurred Giving rise to a new asset or liability Giving rise to a change in an existing asset or liability Rights Access to benefits Evidenced by exposure to risks Likelihood of risks arising Slide 3 3 Substance over form Typical examples: Consignment stocks Sale and repurchase agreements Debt factoring Slide 4 4 Consignment stocks Legal title retained by consignor Consider economic risks and benefits Likelihood of stock being returned Past experience Contractual penalty clauses Slide 5 5 Sale and repurchase agreements Vendor retains control of the asset Asset remains in use Substance not that of normal sale Retain on balance sheet of vendor Slide 6 6 Sale and repurchase agreements Substance is that of finance arrangement Money borrowed on security of asset Repurchase amount will include interest Separate out the interest element Report interest in Income Statement Report as a liability in the balance sheet Slide 7 7 Debt factoring Factoring may be: Without recourse Or With recourse Sale of debts without recourse Any bad debts are suffered by factor Treat cash received from factor as settlement of debts Slide 8 8 Provisions & Contingencies Provisions Affect income statement & balance sheet Contingencies No affect Can be disclosed as note May not even be disclosed at all Provisions Liability of uncertain timing or amount Increase in provision recognised in IS as expense Liability created Provisions are by nature uncertain so Timing and amount has to be estimated Slide 9 9 Recognition Used to be able to use provisions to manipulate accounts Eg loss making business creating provision to cause large loss in 1 year Gradually reduce provision in subsequent years to offset losses/show profits IAS 37 prevents this Company should have present obligation arising from past event Must be probable an outflow of resources embodying economic benefits will be required to clear the obligation Probable = more likely than not to occur Group of small obligations can be lumped together as a class of obligations Should be reliable estimate of amount of obligation Slide 10 10 Non-recognition Provision not recognised unless Obligatory event exists present obligation from past event Settlement of obligation is legally enforceable Eg obligation to make good environmental damage Constructive obligation event creates valid expectation in 3rd party Eg a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period Or decommissioning nuclear power stations Slide 11 11 Measurement & Review Measurement of provision = Best estimate of expenditure required Amount should be estimate before tax If large number of events expected value based on range of outcomes & probabilities Should take account of risks & uncertainties but not use excessive prudence & overstate provisions Reviewing provision At every balance sheet date & adjust to reflect best current estimate If provision is long-term & time value of money is material - should be stated at present value Slide 12 12 Specific applications - 1 Future operating losses Cannot create provision for this no obligating event & no present obligation Specifically outlawed by IAS 37 Onerous contracts Unavoidable costs of meting contract are > than expected economic benefits Provision should be recognised Lowest cost of exiting contract Ie cost of carrying out contract or Cost of penalty for failure to complete contract Slide 13 13 Specific applications - 2 Restructuring costs Incurred when company Sells/closes line of business Closes business location in a country/region of another country Changes management structure substantially Carries out fundamental reorganisation materially affecting nature/focus of operations Provision for restructuring costs only allowed if recognition criteria apply i.e. Detailed & formal plan of restructuring exists outlining expected number/location of employees to be compensated, expenditures to be undertaken & timing of them Should have raised expectation in individuals affected that reorganisation will occur Slide 14 14 Contingent liabilities Possible obligations that arise from past events & whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events that are not wholly within the companys control Or present an obligation arising out of past events that is not recognised as a provision because Not probable outflow of resources needed to settle obligation Obligation cannot be measured satisfactorily Slide 15 15 Contingent liabilities So contingent liability is Possible obligation not yet confirmed Present obligation that does not meet all criteria for recognition as a provision Therefore not recognised as liability If CL is not remote - possibility disclose as note If CL is remote - do not disclose Slide 16 16 Contingent Asset Arises from past events but its existence confirmed by occurrence/non- occurrence of uncertain future events not in the companys control. Eg compensation from a law suit Do not recognise as an asset When realisation of income/asset become virtually certain then recognise Slide 17 17 Disclosures Reconciliation for each class of provision: Opening balance Additions Used (amounts charged against the provision) Released (reversed) Unwinding of the discount Closing balance A prior year reconciliation is not required For each class of provision, a brief description of: Nature Timing Uncertainties Assumptions Reimbursement Slide 18 18 Post balance sheet events IAS 10 Events which could be favourable or unfavourable that occur after the balance sheet date but before accounts are authorised 2 types of events Adjusting event: An event after the balance sheet date that provides further evidence of conditions that existed at the balance sheet including an event that indicates that the going concern assumption in relation to the whole or part of the enterprise is not appropriate. Non-adjusting event: An event after the balance sheet date that is indicative of a condition that arose after the balance sheet date. Slide 19 19 Treatment Adjust financial statements for adjusting events Do not adjust for non-adjusting events If an entity declares dividends after the balance sheet date, the entity shall not recognise those dividends as a liability at the balance sheet date That is a non-adjusting event Slide 20 20 Going Concern Issues Arising After Balance Sheet Date An entity shall not prepare its financial statements on a going concern basis if management determines after the balance sheet date either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so Slide 21 21 Disclosure Non-adjusting events should be disclosed if they are of such importance that non-disclosure would affect the ability of users to make proper evaluations and decisions Required disclosure is the nature of the event and an estimate of its financial effect or a statement that a reasonable estimate of the effect cannot be made Slide 22 22 Disclosure A company should update disclosures that relate to conditions that existed at the balance sheet date to reflect any new information that it receives after the balance sheet date about those conditions. Companies must disclose the date when the financial statements were authorised for issue and who gave that authorisation If the enterprise's owners or others have the power to amend the financial statements after issuance the enterprise must disclose that fact Slide 23 23 IAS 24 - Related party disclosures Objective of IAS 24 To ensure that an entity's financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances with such parties Slide 24 24 Who Are Related Parties? Parties are considered to be related if one party has the ability to control the other party or to exercise significant influence or joint control over the other party in making financial and operating decisions Slide 25 25 Related Entity A party is related to an entity if: (a) directly, or indirectly through one or more intermediaries, the party: (i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries) (ii) has an interest in the entity that gives it significant influence over the entity or (iii) has joint control over the entity (b) the party is an associate of the entity (c) the party is a joint venture in which the entity is a venturer Slide 26 26 Related Entity A party is related to an entity if: (d) the party is a member of the key management personnel of the entity or its parent (e) the party is a close member of the family of any individual referred to in (a) or (d) (f) the party is an entity that is controlled, jointly controlled or significantly influenced by or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e) or (g) the party is a post-employment benefit plan for the benefit of employees of the entity, or of any entity that is a related party of the entity Slide 27 27 Not related Examples where a party is not related: two enterprises simply because they have a director or key manager in common two venturers who share joint control over a joint venture providers of finance, trade unions, public utilities, government departments and agencies in the course of their normal dealings with an enterprise a single customer, supplier, franchiser, distributor, or general agent with whom an enterprise transacts a si