IAS 37 Provisions, contingent assets Véronique Weets · PDF file ·...

IAS 37

Provisions, contingent liabilities and

contingent assets

Véronique Weets

IAS 37 Provisions, contingent liabilities and contingent assets

Instituut van de Bedrijfsrevisoren 27 oktober 2010

FACILITATOR

VÉRONIQUE WEETS

Dr. Véronique Weets is a Professor of International Accounting and a faculty member at two Belgian

universities. In that role she is responsible a general IFRS course and a Financial Instruments course. At

regular occasions she participates in Master Programs of UAMS, Programs of Vlerick and the Solvay

Business School. Véronique Weets was also associated with the IFRS Technical desk of Deloitte in Belgium,

where she was involved in client work on matters such as the transition to IFRS and the subsequent

application of IFRS to listed companies. She was also responsible for client trainings as well as trainings of

the professional staff.

As from 2006 Véronique Weets created her own company in which she helps clients with the application

of IFRS on a daily basis through trainings or consultancy. This means that she actively searches for the

practical translation of this principle based framework of accounting in order to provide realistic solutions

to the clients. Therefore, facilitation sessions provided by Véronique Weets always have a strong

theoretical basis that is translated to practical applications that are relevant to the business environments

of the delegates. In addition to this, Véronique Weets is also an author of a long list of technical

accounting literature in English, French and Dutch.

DISCLAIMER

Whilst every effort is made to ensure that the contents of its case studies and other material handed out

during or in connection with courses are accurate and up‐to‐date, we shall not be under any liability

whatsoever for any inaccuracy or misleading information whether arising for negligence or otherwise and

in particular we shall not be liable for any consequential damage or expense of any loss of profit or any

liability to third parties incurred as a result of reliance on such inaccurate or misleading information.

REFERENCES (OTHER THAN THE OFFICIAL PUBLICATIONS OF THE IASB)

Deloitte, iGAAP 2005 – IFRS Reporting in the UK, CCH

KPMG, Insights into IFRS 2005/6 Edition, Thomson.

PWC, Manual of Accounting – IFRS for the UK 2007, CCH

IAS 37 Provisions, contingent liabilities and contingent assets

Instituut van de Bedrijfsrevisoren 27 oktober 2010

OVERVIEW

IAS 37 – Provisions, contingent liabilities and contingent assets

o Objective and scope

o Definitions

o Recognition

o Measurement

o Specific applications

Future operating losses

Onerous contracts

Restructuring plans

Other practical applications

o IFRIC 1 – Changes in existing decommissioning, restoration and similar liabilities

o IFRIC 6 – Liabilities arising from participating in a specific market – waste electrical and

electronic equipment

o IFRIC 13 – Customer loyalty programmes

o Financial guarantee contracts

o Emission rights

Recent developments

o ED amendments to IAS 37

o ED 2010/1 Measurement of liabilities in IAS 37


1Instituut van de Bedrijfsrevisoren27 oktober 2010

IAS 37 Provisions, contingent liabilities and contingent assetsVéronique Weets ([email protected])

© Veronique Weets 20101

Overview


Objective and scope

Definitions

Recognition

Measurement

Specific applications

Future operating lossesp g

Onerous contracts

Restructuring plans




Overview


IFRIC 1 – Changes in existing decommissioning, restoration and similar liabilities

IFRIC 6 – Liabilities arising from participating in a specific market – waste electrical and electronic equipment

IFRIC 13 – Customer loyalty programmes

Financial guarantee contracts

Emission rights

Recent developments

ED Amendments to IAS 37

ED 2010/1 Measurement of liabilities in IAS 37



4



Objective and scope

Objective Ensure appropriate recognition criteria and measurent bases for provisions contingent liabilities and contingent assetsfor provisions, contingent liabilities and contingent assets

Ensure that sufficient information is disclosed to enable users to understand nature, timing and amount

Scope Accounting for provisions, contingent liabilities and contingent assets, except those that result from Executory contracts (unless onerous)y ( ) Contracts under which neither pary has performed any of its obligatins or both parties have partially performed their obligations

Those dealt with in an other IFRS (IFRS 3, IAS 11, IAS 12, IAS 17, IAS 19, IFRS 4, IAS 18 , IAS 32/39)


Definitions

A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to

l fl f h fresult in an outflow from the enterprise of resources embodying economic benefits.

A provision is a liability with uncertain timing and/or amount.




Definitions

Recognize a provision when: There is a past event (“Obligating event”) that led to a present obligationobligation

There is a present obligation Legal obligation (contract, law,…)

Constructive obligation entity has indicated acceptance of responsibility (e.g. by established pattern, published policies, specific statement) and as a result created valid expectation of discharge

Economic outflow is probable Economic outflow is probable More likely than not

Reliable estimate can be made Rebuttable presumption


Definitions

A contingent liability should be disclosed when

There is a present obligation as a result of a past event:

That probably requires an outflow of economic benefits, but the obligation cannot be measured

That may, but will probably not, require an outflow of resources embodying economic benefits

There is a possible obligation as a result of a past event, that may, but probably not, require an outflow of resources.




Definitions

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 futureoccurrence or non‐occurrence of one or more uncertain future events not wholly within the control of the enterprise.

Assets should be recognised when controlled, not when probable

Only recognise when virtually certain

Example:

a reimbursement by an insurance company is recognised as an asset when receival is virtually certain

No netting in balance sheet

Netting in income statement is allowed


Measurement

The provision should be measured at the best estimate of the expenditure required to settle the present obligation

h d f h dat the end of the reporting period

The amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party




Measurement

Consider

Risks & uncertainties

Prudence, but remain neutral and reliable

Take into account in cash flows or in discount rate

Legal & technological changes

Time value of money if material

Pre‐tax cash flows and pre‐tax discount rate

Evidence provided by events that take place after the end of p y pthe reporting period

Do not consider

Gains from expected disposal


Measurement

Discount rate should take into account Inflation, unless cash flows are expressed in current prices

)(1 R

Unwinding of provision should be measured at nominal rate and included as borrowing cost

Risks and uncertainties concerning amount, unless reflected in cash flows

1)(1

)(1)(

iR

nRrR

flows

Tax effect

Government bond rates are risk‐free and usually pre‐tax




Measurement

Inability to estimate is rare

Review & adjust for current best estimate

Reverse when outflow is not longer probable

Effect of expected reimbursement (e.g. insurance):

Recognize only when virtually certain to be received

Amount should not exceed provision amount

Recognize reimbursement as separate asset

May present provision expense net of reimbursement in the income statement



Operating losses Do not recognize provisions for future operating losses

E t d ti l i di t i i t Expected operating losses may indicate impairment

Test assets for impairment under IAS 36

Recognize onerous contract obligations as a provision An onerous contract is a contract where the unavoidable costs exceed the expected benefits to be received

S ifi i h b d di d i l i Specific assets might be dedicated to a particular contract, in which case, before a separate provision for an onerous contract can be made, it is necessary to recognise any impairment loss for those assets in accordance with the rules set out in IAS 36.




Special applications

Restructuring plan

Program planned & controlled by management that materially changes either:

Scope of business

Manner of conducting business

Recognize provision when the recognition criteria are met



Recognition of restructuring provision requires detailed formal plan including:

Business or part involved

Principal locations affected

Location, function, # employees who will be compensated for termination

Expenditures that will be undertaken

When implemented p

AND...





A valid expectation to carry out this plan

Announcement of main features

Start of implementation

Binding sale agreement when restructuring involves sale of an operation



Restructuring costs: Include direct expenditures, which are both:

Required as part of restructuring & Required as part of restructuring, &

Not ongoing activities

Do not include: Retraining or relocating continuing staff

Marketing

Investment in new systems & distribution networks

Examples Remuneration of employees engaged in dismantling plant and disposing Remuneration of employees engaged in dismantling plant and disposing of surplus stocks

Costs of making employees redundant

Costs or terminating leases and other contracts, the termination of which results directly from the reorganisation




Contingent liabilities

Possible obligation only confirmed by future events not within entity’s control; or

Present obligation not recognized because:

Economic outflow is not probable; or

Amount cannot be reliably measured

Disclose unless possibility of outflow is remote


Contingent assets

Possible assets:

Due to past events

Will be confirmed by future events not within entity’s control

Disclose when economic benefit inflow is probable





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IFRIC 1 ‐ – Changes in existing decommissioning, restoration and similar liabilities

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Special topics: Changes in ARO (IFRIC 1)

IAS 37 requires the amount recognized as a provision to be the best estimate of the expenditure required to settle h bl h / dthe obligation at the B/S date.

Changes in this estimate are due to:

Revision of estimated cash flows (e.g. estimated costs of decommissioning a power plant)

Revisions to the current market‐based discount rate Revisions to the current market‐based discount rate

Increase in the liability that reflect the passage of time – also referred to as the unwinding of the discount


Special topics: Changes in ARO (IFRIC 1)

Changes in the estimated decommissioning costs and changes in discount rates:

F i i i h d l h i li d f For entities using the cost model, changes are capitalized as part of the cost of the item and depreciated prospectively over the remaining life

Under the FV model, a change in the liability is not capitalized but alters the revaluation surplus or deficit on the item (change in surplus is adjusted to equity; change in deficit is recognized in net income)

An increase in the liability that reflects the passage of time (accretion) – also referred to as the unwinding of the discount – is recognized in profit or loss as a finance cost as it occurs




IFRIC 6 – Liabilities arising from participating in a specific market –Waste electrical and electronic equipment

25

Background

EU Directive on Waste Electrical and Electronic Equipment (WE&EE) :

Historical waste (products sold < 13 August 2005)

New waste (products sold > 13 August 2005)

Waste from private households

Waste from sources other than private households

“Cost of waste management for historical household Cost of waste management for historical household equipment to be borne by producers that are in the market at the measurement period”




Scope

Recognition of liabilities in the financial statements of producers of electrical and electronic equipment for sales f h l h h ldof historical household equipment

Outside scope :

Measurement of such liabilities: IAS 37

New equipment (household and other)

Historical equipment from sources other than households Historical equipment from sources other than households


Issue and consensus

Issue: What is the obligating event ? Manufacturing or sale of HHE ?

P ti i ti i th k t d i t i d? Participating in the market during measurement period?

Incurrence of cost for waste management activities ?

Consensus : Participating in the market during measurement period

Consequence : No obligation unless and until market share in measurement period

Timing obligating event >< timing waste management / cost




IFRIC 13 – Customer loyalty programmes

29

Scope and transitional provisions

IFRIC 13 applies to customer loyalty award credits that

An entity grants as part of a sales transaction; and

Subject to meeting any further qualifying conditions, the customers can redeem in the future for free or discounted goods or services

Entities shall apply the interpretation for annual periods beginning on or after 1/7/2008 g g

No transitional provisions




Accounting treatment

Award credits supplied in the context of a customer loyalty programme should be accounted for as a

l d f bl f h lseparately identifiable component of the sales transaction in which they are granted (IAS 18.13).

This requires:

Allocation of some of the consideration received or receivable to the award credits andto the award credits and

Deferral of the recognition of revenue until the award credits are redeemed


Measurement

Allocation of the consideration to the award credits by reference to their fair value, i.e.:

Based on the relative fair values of each component of the sale, or

Equal to their fair value.

Allocation by reference to the cost of the award credits is prohibited !prohibited !




Practical application French construction and media company Bouygues adopts early IFRIC 13 "Customer loyalty programmes" and derecognizes a €166 million liability relating to its telecoms activities. Bouygues discloses that the effects of early adoption of IFRIC 13 are

derecognition of a €166 million opening customer loyalty programme provision for 2006.

After consequent adjustment to deferred tax, this results in a €109 million increase in opening equity in the comparative figures.

There is no impact on revenue. The company tells us that it previously applied French GAAP and that the change results from the fair valuation of fidelity points awarded to the general public in its telecoms businessof fidelity points awarded to the general public in its telecoms business.

This is the first instance we have seen of early adoption of IFRIC 13 and shows that the new Interpretation can have a significant impact on provisions. The Interpretation is currently in process of approval by the European Union.



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Background


contracts that require the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument

2005 Amendment to IAS 39 and IFRS 4

These contracts are within the scope of IAS 39, but if the issuer p ,previously asserted explicitly hat it regards such contracts as insurance contracts, the issuer may elect to apply either IAS 39 or IFRS 4.


Treatment under IAS 39

Initial measurement at fair value

S b Subsequent measurement At the higher of

The amount determined in accordance with IAS 37 and

The amount initially recognized less, when appropriate amortization recognized in accordance with IAS 18

If a credit guarantee meets neither the definition of a financial guarantee contract in IAS 39 nor the definition offinancial guarantee contract in IAS 39 nor the definition of an insurance contract in IFRS 4, the issuer applies IAS 39, because such a contract is a derivative Example: a contract that requires payments if the credit rating of a debtor falls below a particular level




IFRIC 3 – Emission rights (withdrawn)

37


Entities have three options

Limit its emissions to its cap

Reduce its emissions to below its cap and sell (or carry forward) the allowances that it does not require

Produce emissions in excess of its cap, in which case it must buy additional allowances for the excess of its cap, in which case it must buy additional allowances for the excess emissions and/or incur a penalty.





A cap and trade scheme gives rise to:

An asset for allowances held

Allowances, whether issued by government or purchased, are intangible assets

Allowances that are issued for less than fair value shall be measured initially at their fair value !

A government grant

When allowances are issued for less than fair value, the difference between the amount paid and fair value is a government grantbetween the amount paid and fair value is a government grant

A liability for the obligation to deliver allowances equal to emissions that have been made.

Measured at the best estimate: usually present market price



EC decided not to endorse (May 2005)

Intangible measured at fair value through profit and loss ?

Apply hedge accounting model ?

Mismatch measurement and presentation

IASB decided to withdraw (June 2005) and to have project on government grants including emission rights

Currently: « Reconsideration of IFRIC 3 has been deferred pending the conclusion of work on other relevantpending the conclusion of work on other relevant projects »




CBN 179‐1 Boekhoudkundige verwerking van broeikasgasemissierechten/ Traitement comptable des quotas

d’émission de gaz à effet de serre

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Gross method

Recognise emission rights as intangible assets

Measure at purchase price if purchased in market

Measure at fair value if received at cost lower than fair value

Difference in other income

Can be deferred until emission

Recognise a liability for the emission

Measure at initial cost of the rights for rights held by the entity

Measure at fair value on balance sheet date for rights to Measure at fair value on balance sheet date for rights to purchase




Net method

Calculate at balance sheet date

Number of rights needed

Number of rights held

Recognise difference as asset/liability

Measured at fair value on balance sheet date though profit and loss statement


Recent Developments

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45


Scope

Apply to all liabilities not within scope of another standard

Except executory contracts, unless onerous

Eliminate ‘contingent’ liabilities

Currently describes two different ideas

Unrecognized present obligation

Possible obligation (business risk)





Present obligations are liabilities

Non‐recognition inconsistent with Framework and other standards

Business risks are not liabilities

Recognition inconsistent with Framework



Lawsuits

Claim against company <> obligation

Claim may be evidence that an obligation exists

More guidance on identifying liabilities

Distinguishing business risks from liabilities

Need for evidence to support judgment that present obligation exists

More guidance on measurement More guidance on measurement

Expected value calculations




ED 2010/1 Measurement of liabilities in IAS 37

49

ED 2010/1 Main provisions

Account for uncertainty about the amount and timing of outflows by using the probability‐weighted average of the

fl f h f bloutflows for the range of possible outcomes. Elimination of probability criterion

Measured at the amount that the entity would rationally pay at the measurement date to be relieved of the liability.

estimate of the present value of the resources required to


p qfulfill the liability based on expected outflows of resources, the time value of money, and the risk that the actual outflows might ultimately differ from the expected outflows.

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ED 2010/1 Main provisions

Liability to pay cash to a counterparty (for example to settle a legal dispute)

expected cash payments plus any associated costs, such as legal fees.

Liability is to undertake a service (for example, to decommission plant) at a future date

amounts that the entity estimates it would pay a contractor at the future date to undertake the service on its behalf.





Disclaimer Cethys takes every care in preparing course material to ensure that the

content is accurate and up to date. This course material does not provide an exhaustive presentation of treatment of topics presented in accordance p f f p pwith IFRS. As such, when evaluating the underlying accounting treatment, the original IFRS Standards and Interpretations should be consulted, and an advice of a qualified IFRS expert should be obtained when deemed necessary. No responsibility for loss occasioned to any person acting or refraining from acting as a result of such material can be accepted by Cethys or Véronique Weets.


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