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Deliberation on IFRS IAS-37
Provision, Contingent Liabilities and Contingent Assets
by CA. D.S. Rawat
Scope
Accounting for – Provisions Contingent liabilities Contingent assets
Scope
Exclusion – Those resulting from executory contracts,
except where the contract is onerous; and Those covered by another Standard
Definitions
Provision is a liability - A present obligation legal or constrictive as
a result of past event Outflow of resources involved to settle the
obligation Reliable estimate can be made of that
obligation
Definitions
Liability - A present obligation arising from past events,
the settlement of which is expected to result in an outflow of resources embodying economic benefits.
Definitions
Obligating event – Create a legal or constructive obligation Results in an entity having no realistic
alternative but to settle it. Legal obligation- Derive from law (e.g. contract, statute,
courts etc)
Definitions
Constructive liability - Established through pattern of past practice,
published policies, a specific current statement and valid expectations created that it will be settled.
Definitions
Contingent liability A possible obligation from past events
whose existence will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events that are not wholly within the control of the entity; or
Definitions
Contingent liability a present obligation from past events that is
not recognised because – - an outflow of economic benefits is not
probable; or - the obligation cannot be measured with
sufficient reliability
Definitions
Contingent assets A possible asset, that arises from past
events, whose existence will be confirmed only on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity
Definitions
Onerous Contract The unavoidable costs of the contract
exceed the benefits to be obtained
Recognition issues
Warranties Contaminated land Refunds Future legal requirement Staff re-training Refurbishment costs
Measurement
The amount provided should be the best estimate at the end of the reporting period of the expenditure requires to settle the obligation Often expressed as the amount - - which could be spent to settle the
obligation immediately; or - To pay to third party to assume it
Measurement
May use - - Expected values - Most likely outcome - present value
Measurement example A warranty covers costs of repairing
manufacturing defects discovered within 12 months of purchase. Repair costs for all products are estimated at –
$ 100,000 for minor defects $ 400,000 for major defects Past experience indicate that of goods sold 75% will have no defects 20% will have minor defects 5% will have major defects
Change in provisions
Provisions should be reviewed regularly and if the estimate of the obligation has changes, the amount recognised as a provision should be revised accordingly. Provision may be used ONLY for the
expenditures that relate to the matter for which they were originally recognised.
Provision Accounting An entity becomes subject to an obligating event
on 1st Jan 09.As a result, it is committed to expenditure of $10m in 10 years time. An appropriate discount factor is 8%
Initial measurement $10m x 1/(1+0.08)10 = 4.632 Profit or loss Dr. 4.632 To Provision 4.632
Provision Accounting Re-measurement $10m x 1/(1+0.08)9 = 5.003 Financial position notes extract $m Balance brought forward 4.632 Borrowing costs (8% x 4.632) 0.371 Carried forward 5.003 Profit or loss Dr. 0.371 To Provision 0.371
Provision Accounting Re-measurement $10m x 1/(1+0.08)8 = 5.403 Financial position notes extract $m Balance brought forward 5.003 Borrowing costs (8% x 5.003) 0.400 Carried
forward 5.403 Profit or loss Dr. 0.400 To Provision 0.400
Decommission costs
Costs of removing/restoring a production facility A provision should be recognised as soon a
an obligating event occurs This may be at the start of the contract The debit may be the cost of the asset (IAS
16 specifically allows for)
Environmental damage example X has an obligation to restore environmental
damage. Restoration will be carried out as follows- Phase (1) to remove the contaminated soil will cost
$2m in the year to 30th June2009 Phase (2) replanting the area is estimated to cost
$3.5m three years later Pre-tax cost of capital is 10% Expenditure, when incurred, will attract tax relief at
30% Calculate the provision at 30th June 2008
Contingent liabilities and assets Do not recognise disclose contingent liabilities (as outflow of
economic benefit is only ‘possible’) ignore contingent liabilities if remote Recognise contingent assets if virtually
certain Disclose contingent assets if probable
Future operating losses No provision should be made - the losses do not arise out of a past event - they are not unavoidable However, the expectation of future losses
may indicate the need for an impairment loss to be recognised
Reimbursements Where some or all of the expenditure required
to settle a provision 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.
Restructuring -definition A programme that is planned and controlled
by management and materially changes either –
- the scope of a business undertaken by an
entity or - the manner on which that business is
conducted
Restructuring -example Example include - Sale or termination of a line of business Closure of business locations in a region Relocation from one region to another Changes in management structure Fundamental re-organization
Restructuring -provision A provision should only be recognised
when a constructive obligation to restructure has occurred A number of conditions must be met The provision should include only those
expenditures that are both – - Necessarily entailed by the restructuring - Not associated with the on going activities
Restructuring -conditions Detailed formal plan for the restructuring
(minimum requirements specified) A valid expectations has been raised by: - starting to implement the plan; - announcing its main features to those
effected by it There is no obligation for the sale of an
operation until there is a blinding sale agreement
Restructuring costs Redundancy cost Costs of retraining/relocating continuing staff Contract termination costs Marketing Investment in new distribution networks Future operating losses up to the date of
restructuring Gains on expected disposal of assets Sundry expenditures incurred in the
reorganization
Disclosure For each class of provision- Carrying amount at the beginning Additional provision made, increase to the
existing provision Amount used Unused amount reversed Increase during the period in discounted
amount due to passage of time
Disclosure For each class of provision, the entity shall
disclose brief description of the nature obligation and the expected timing, indication of the uncertainties about the amount.
For each class of contingent liability a brief
description and nature and, where practicable, estimate of its financial effect and indicating the uncertainties and the possibility of any reimbursement
THANK
YOU
CA, D.S.RAWAT
Deliberation on IAS-12 ‘Income Tax’
by CA. D.S. Rawat
Objective
The main issues addressed in the Standard is the accounting for the current and future tax
consequences of: the future recovery (or settlement) of the carrying amount of assets (or liabilities) in an entity’s statement of financial position ; and transactions and other events of the current
period in an entity’s financial statements.
Scope
Included – Domestic/foreign income taxes Income taxes/withholding taxes paid on
distribution Excluded - Other taxes (e.g. VAT) that are lived on
another basis (e.g. on gross revenue) Government grants
Factor in determining an income-tax
IAS-12 defines ‘income taxes’ as ‘all domestic and foreign taxes, which are based on taxable profits. Income taxes also include withholding taxes
payable by subsidiary, associate or joint venture on distributions to the reporting entity
Current tax - Measurement
Amount expected to be paid to tax authority using enacted or substantively enacted tax rates and tax laws by the end of the reporting period
Deferred Tax
Balance sheet approach Recognise deferred tax for temporary
differences Full provision with limited exceptions Initial recognition exception
Basic equations
Deferred tax = Temporary Difference x tax rate Temporary difference = Carrying amount – Tax base
‘Temporary’ differences v/s timing differences
Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base Timing differences are differences between
profits or losses as computed for tax purposes and results as stated in financial statements.
Tax base of an asset it is the amount that will be deductible for tax
purposes against any taxable economic benefit that will flow to an entity when it recovers the carrying amount of the asset
Tax base of a liability it is its carrying amount, less any amount that
will be deductible for tax purposes in respect of that liability in future periods.
Accounting for deferred tax – a five step approach Calculate tax base Calculate temporary difference Identify the temporary differences that give rise
to deferred tax assets or liabilities Calculate deferred tax balances using appropriate
tax rate Recognise deferred tax in profit or loss, other
comprehensive income, equity or as an adjustment to goodwill (only in limited circumstances)
Step 1: Calculate tax base
Tax base ‘the amount attributable to that asset or liability
for tax purposes’ ‘the tax base of an asset is the amount that will
be deductible for tax purposes against ay taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset’
Tax base – Some Examples
A machine cost 100. for tax purpose, depreciation of 30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deductions on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purpose – the tax base of the machine is 70
Tax base – Some Examples
Interest receivable has a carrying amount of 100. The related interest revenue will be taxed on a cash basis. The tax base of the interest receivable is Nil. trade receivables have a carrying amount of
100. The related revenue has already been included in taxable profit (tax loss). The tax base of the trade receivables is 100.
Tax base – Some Examples
Current liabilities include accrued expenses with a carrying amount of 100. the related expense will be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is Nil. Current liabilities include accrued expenses
with a carrying amount of 100. The related expense has already been deducted for tax purposes. The tax base of the accrued expenses is 100.
Step 2: Temporary differences
Temporary difference = carrying amount – tax base For non-taxable assets, and non-deductible
liabilities, tax base = carrying amount temporary difference is Nil
Recognition exceptions General rule is to recognise-subject to
specific exceptions Exceptions – -Goodwill on acquisition -Certain differences related to investments in
subsidiaries, branches, associates and JV - Initial recognition, other than business
combinations, of an asset/liability which affects neither accounting profit/loss not taxable profit
Recognition exceptions
Deductible difference – recognised only to the extent that recoverability is probable
Goodwill on acquisition
Specifically goodwill that is not tax deductible (goodwill on acquisition that is not taxable) If deferred tax were recognised –would
decrease net assets and change the amount of goodwill which would have consequential tax effects Never recognise a temporary difference in
respect of goodwill on acquisition
Example – Tax deductible Goodwill
If goodwill acquires in a business combination has a cost of 100 that is deductible for tax purposes at the rate of 20% per year starting in the year of acquisition. Tax base of the goodwill is 100 on initial
recognition and 80 at the end of the year of acquisition.
Example – Tax deductible Goodwill
If the carrying amount of goodwill at the end of the year of acquisition remains unchanged at 100, a taxable temporary difference of 20 arises at the end of that year Because that taxable temporary difference
does not relate to the initial recognition of the goodwill, the resulting deferred tax liability is recognised.
Difference associated with investments in subsidiary/Associates/JCE
No temporary difference where recovery has no tax impact Temporary difference is the difference
between the carrying amount of the investment (share of net assets) and the tax base (historical cost)
Difference associated with investments in subsidiary/Associates/JCE Difference required to be recognised, except
for taxable temporary difference where – - the investor is able to control the reversal - it is probable that the difference will not reverse
in the foreseeable future Generally Ok for parent/subsidiary, and may
be jointly controlled entity - but never associate (no control)
Initial recognition
Temporary differences are not permitted to be recognised where the difference arises in respect of the initial recognition of an asset or liability in a transaction which –
- is not a business combination and - at the time of the transaction affects neither
accounting profit (loss) nor taxable profit (loss)
Initial recognition exception
Do not recognise deferred tax impact
Was the asset or liability acquires in a business combination
Did the transaction affect either the accounting result or the taxable profit
(loss) at the time of the transaction
Does the temporary differences arise on the initial recognition of an assets or a liability
Recognise deferred
tax impact (subject to
other exceptions)
No
No
Yes Yes
No
Yes
Recoverability of deductible temporary differences
Deductible temporary differences are only recognised to the extent that it is probable that sufficient taxable profit will be available against which the deductible temporary difference can be utilized A deferred tax asset represents a future tax
deduction - Valuable only if the enterprise will have future taxable
profits against which the deduction can be offset
Recognition of deferred tax assets
Ongoing obligations: -Where recognised, reconsider at every
reporting date -Where not recognised, reconsider at every
reporting date. If recoverability tests met, recognise at the later date
Step 4: Computation of deferred tax
DTL/DTA = temporary difference x tax rate DTA = Unused tax losses x tax rate Prohibits the use of discounting for the
measurement of deferred tax assets and liabilities
Tax rate
The tax rate that is expected to apply when the temporary difference reverses
current tax rate will generally be the best estimate if not known Based on rates enacted or substantively
enacted by the end of the reporting period Specific rules for progressive tax rates, and
other circumstances where tax rates vary
Step 5: Recognition of movements
Where’s the other side of the entry? - Profit or loss - Except where: - relates to an item dealt with in other comprehensive
income e.g. revaluation, exchange difference, equity component of convertible bonds or equity, deferred tax also recognised in other comprehensive income/equity
- arises in relation to a business combination – effectively adjusted goodwill
Presentation – Current/Non-current
When an entity presents current and non-current in the statement of financial position, it shall not classify deferred tax assets (liabilities ) as current assets (liabilities)
Business combination
The cost of the acquisition is allowed to the identifiable assets and liabilities acquired by reference to their fair values at the date of the exchange transaction. Temporary differences arise when the tax
bases of the identifiable assets and liabilities acquired are not affected by the business combination or not affected differently
Business combination
Deferred tax must be recognised in respect of the temporary differences. This will affect the share of net assets and thus the goodwill (one of the identifiable liabilities of the subsidiary is the deferred tax balance). The goodwill itself is also a temporary
difference but IAS-12 prohibits the recognition of deferred tax on this item.
Deferred tax principle
Tax base
carrying amt
temp. diff
fair value
temp. diff
Consideration 200 Asset Properties 100 110 10* 130 30 Inventory 10 10 - 20 10 Intangible - - - 50 50 Liabilities (20) (20) - (20) DTL Tax rate 30% of 90 (27) Goodwill 47 *Temporary difference not recognised due to initial recognition exception
Business combination
watch out for ‘initial recognition’ exceptions in subsidiary's accounts – will not apply in the consolidated financial statements if they arose pre-acquisition because, from the group‘s perspective, they arose in connection with a business combination
Elimination of unrealized profit on combination
unrealized profits eliminated change the carrying amount without changing the tax base The tax base is the uplifted cost in the books
of the purchaser A deferred tax asset arises, calculated using
the tax rate of the purchaser
Comparison with Ind AS 12
Consequential differences on account of not allowing fair value model in Ind IAS 40, different accounting treatment of bargain purchase in IAS 103 not allowing option of deducting specified grant from the cost of the related asset in IAS 20.
IFRS-2 Share-based Payment
by CA, D.S. Rawat
Share plans and share option plans have become a common feature of remuneration packages for directors, senior executives and other employees in many countries.
An agreement between the entity and an employee (or other party) to enter into a share-based payment transaction which entitles the employee to receive:
equity instruments (including shares) of the entity; or
cash (or other assets) for amounts based on the price of the entity’s instruments,
Provided any specified vesting conditions are met.
Share-based payment transaction: A transaction in which the entity:
receives goods or services as consideration for equity instruments of the entity (including shares or share options); or
acquires goods or services by incurring liabilities (to the supplier of those goods or services) for amounts based on the price of the entity’s equity instrument(s).
The Standard identifies three types of share-based payment transactions:
equity-settled share-based payment transactions; cash-settled share-based payment transactions; and Share based payment transaction with cash
alternatives.
The entity receives services as consideration for
equity instruments of the entity (including shares or share options).
.
The entity acquires goods or services by incurring
liabilities for amounts that are based on the price (or value) of the entity’s equity instrument's).
Cash Settled
of shares to effect combination
uish between in for control and
mployees of the
sed payments in AS-32 & 39 –
to buy a non-
Equity-settled transactions The fair value of the services received (and the
corresponding increase in equity) is measured either: directly, at the fair value of the services received; or indirectly, by reference to the fair value of the equity
instruments granted. - Direct measurement is at the date the entity receives
the services (or obtains the goods). - Indirect measurement, as a surrogate, is at the grant
date.
Quiz –X Ltd hires 20 people from Y Ltd for assistance in the book-keeping services for an IOP. X Ltd will pay a fixed monthly amount of Rs. 25000 per employee to Y Ltd. Y Ltd has no obligation on the performance of the hired people.
X Ltd awards share appreciation rights to its employees including the hired people. Proceeds from exercise of the rights will be paid net of employee income taxes
Defined as the date at which the entity and another party (including employees) agrees to share-based payment arrangement, being the entity and the counterparty have a shared understanding of the terms and conditions of the arrangement.
at the grant date the entity confers on the counterparty the right to cash, other assets, or equity instruments provided vesting conditions are met.
Why is grant date important ? Date of measurement of fair value of options
granted to employees
When equity instruments granted vest immediately, employees (executives or other suppliers) are not required to complete a specified period of service before becoming unconditionally entitled to those equity instruments.
Unless there is evidence to the contrary, the entity presumes that services rendered by the employee have been received. So, on grant date the entity recognizes:
- the services received in full; and - a corresponding increase in equity.
If the equity instruments granted do not vest until a specified period of service has been completed, it is presumed that the services to be rendered as consideration will be received over the future vesting period.
Services must then be accounted for as they are rendered by the employee during the vesting period, with a corresponding increase in equity.
The expected vesting period at grant date is estimated based on the most likely outcome of the performance condition.
A performance condition may be a market condition (i.e. a condition upon which the exercise price, vesting or exercisability of an equity instrument is related to the market price of the entity’s equity instruments).
Quiz – X Ltd purchases 1000 computers in exchange for 5000
ordinary shares trading at Rs. 1000 each. The seller generally sells the computers for Rs. 5500 each.
what is the appropriate value at which the transaction should be recorded at and why?
Black Scholes Assumes exercise at one point Strengths - Wide acceptance - Easy to compute Weakness - Does not allow for variability - Cannot take account of market-based performance
Share based payment transactions that will be settled in cash or other assets Measured at the FV of the liability at each reporting
date Changes in FV are recognized in profit or loss FV estimation should take into consideration
expected forfeitures
.
The tax expense within the profit or loss will be credited with the double entry to the recognition of the deferred tax asset.
The amount that can be credited within profit or loss
is set as a maximum, being the cumulative share option expense × tax rate. Any additional benefit will be credited through other comprehensive income.
Nature and extent of schemes in place
How fair value was determined Effect of expenses arising
100 options each that vest if employed in 3 years. Fair value per option = Rs. 15. Total grant date value? Adjust expense for actual vested shares since there is
non- market vesting condition. 750,000 (= 200 x 100 x15) Rs. 250,000 each year
Cont…
If 80% are expected to vest (and does vest): Year 1 - Rs. 200,000 = [250,000 x 80%] Year 2 - Rs. 200,000 = [500,000 x 80% -200,000] Year 3 – Rs. 200,000 = [750,000 x 80% - 400,000] Rs. 600,000 total expense over three years [50,000 options x 80%] x Rs. 15
Cont…
IF At the end of Year 1: expected 85% of options vest; At the end of Year 2 : expected 88% of options vest; At the end of Year 3: 44,300 shares (or 88.6%) actually vest. Year 1 - Rs. 212,500 = [250,000 x 85%] Year 2 - Rs. 227,500 = [500,000 x 88% -212,500] Year 3 – Rs. 224,500 = [750,000 x 88.6% - 440,000] Total expense = Rs. 664,500 [Rs. 15 x 44,300]
All employees resign during period 3 without receiving options (or another non-market vesting condition is not met)
Year 1 - Rs. 200,000 = [250,000 x 80%] Year 2 - Rs. 200,000 = [500,000 x 80% -200,000] minus Year 3 – Rs. 400,000 = [500,000 x 80%] Rs. 0 total expenses reduced to zero – because no options vest
100 options each at 01.01.2005 Fair value per options = Rs. 25 500 employees Vesting condition Average net profit for next 3 years increase < 10%
Cont..
2005 Net profit increased by 17% and 20 employees left Expect profit will continue and further 20 employees will
leave during 2006 [500-20-20] x 100 x 25 x1/3 = 383,333
Cont..
2006 Net profit increased by 10% and 25 employees left Expect net profit will increase 8% in 2007 (average for
each year more than 10%) and further 10 employees will leave
[500-20-25-10] x 100 x 25 x 2/3 = 383,333
Cont..
2007 Net profit increased by 8.5%, results in an average increase
of more than 10% 450 employees received 100 shares Year 2005 - Rs. 383,333 Year 2006 – Rs. 358,334 Year 2007 – Rs. 383,333* *[450x100x25] – [383,333+358,334]
Cont..
100 options each that vest if employed in 3 years, however, the share option cannot be exercised unless the share price increases by 20% at the end of 2007.
Fair value per option (after taking into account the market performance conditions) Rs. 25
10 Directors
Cont..
If the company expect s the directors to complete the 3 years service and the directors do so.
In year 2006, it is assessed that the probability of an increase in the share price of 20% by the end of 2007 is remote
2005 - Rs. 8,333 = [10x100] x 25x1/3 2006 - Rs. 8,333 = [(10x100) x 25x2/3] –8,333 2007 - Rs.8,334 = [(10x100)X25] –8,333-8,333
Cont..
The possibility that the share price target might not be achieved is taken into account when estimating the fair value at grant date
.
THANK YOU
CA, D.S.RAWAT
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