Download - Workshop on IFRS KKTulshan. IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Workshop on IFRS

KKTulshan

IAS 37

Provisions,

Contingent Liabilities and Contingent Assets

IAS 37 v AS 29

IAS 37 Constructive obligation Discounting

AS 29 No guidance

Objective

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 understand their Nature Timing and Amount

Exclusions

Executory contracts unless onerous contracts Covered by other standards

IAS 11 : Constructions Contracts IAS 12 : Income-taxes IAS 17 : Leases IAS 19 : Employee Benefits IAS 39 : Financial instruments IFRS 4 : Insurance Contracts

How about provisions for Depreciation, Impairment of assets, and Provisions for doubtful debts?

Provisions

Provisions

Definitions

A provision is a liability of uncertain timing or amount.

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

Distinction – Provisions v Other liabilities A provision is a liability of uncertain amount or timings

Trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier

Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees

Accruals are often reported as part of trade and other payables

Provisions are reported separately

Recognition

A provision shall be recognized when all the following three conditions are met.

Condition 1: An entity has a present obligation (legal or constructive) as a result of a past event

Condition 2: It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation

Condition 3: a reliable estimate can be made of the amount of the obligation

Recognition – Condition 1

An entity has, as a result of a past event, a present obligation (legal or constructive).


Past Event The past event is known as obligating event 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

When no realistic alternative exists: When settlement can be enforced by law; or When the event creates valid expectations.


Present obligation could be of two types: legal or constructive A legal obligation is an obligation that derives from

A contract (through its explicit or implicit terms) Legislation; or Other operation of law

Examples:

A constructive obligation is an obligation that derives from an entities actions where: 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

As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities

Examples:


Probability of a present obligation In almost all cases it will be clear that past event has

given rise to present obligation In rare cases it is not clear whether there is a

present obligation Apply probability criteria More likely than not Consider all available evidence Additional evidence – events after reporting date

Obligation should exists independently of entity’s future action.


Probable outflow of economic outflows Probable means more likely than not


Reliable estimate Rationally pay Third party

Best estimate Consider

Risks and uncertainties Present Value Future Events

Ignore Expected disposal of assets Reimbursements

Measurement – General Rules Best estimate Risks and uncertainties Present Value Future Events Expected disposal of assets Reimbursements

Measurement – Best Estimate The amount recognized as a provision shall

be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period

The best estimate of the expenditure required to settle the present obligation is 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 at that time

Measurement – 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

A risk adjustment may increase the amount at which a liability is measured

Caution is needed in making judgements under conditions of uncertainty, so that income or assets are not overstated and expenses or liabilities are not understated

Uncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities

Measurement – Present Value Where the effect of 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

Measurement – Future Events It is only those obligations arising from past events existing

independently of an entity’s future actions (ie the future conduct of its business) that are recognized as provisions

Future events that may effect 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

Examples Expected cost reductions associated with increased experience in

applying existing technology However, an entity does not anticipate the development of a

completely new technology unless it is supported by sufficient objective assessment

The effect of possible new legislation is taken into consideration in measuring an existing obligation when sufficient objective evidence exists that legislation is virtually to be enacted

Measurement – Expected disposal of assets Gains from expected disposal of assets shall

not be taken into account in measuring a provision

Measurement - Reimbursements The reimbursements shall be recognized

when, and only when, it is virtually certain that reimbursements will be received if the entity settles the obligation

The reimbursement shall be treated as a separate asset

The amount recognized for the reimbursements shall not exceed the amount of the provision

Changes in provision

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, reverse the provision

If there is no longer uncertainty about timing and amount, the provision becomes a liability

Use of provisions

A provision shall be used only for expenditures for which the provision was originally recognized.

Discussion 1 - Warranties

A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale. On past experience, it is probable (ie more likely than not) that there will be some claims under the warranties.

D1 – Warranties – Solution

Present obligation as a result of a past obligating event: The obligating event is the sale of the product with a

warranty which gives rise to a legal obligation An outflow of resources embodying economic

benefits in settlement: Probable for the warranties as a whole

Conclusion: A provision is recognized for the best estimate of the costs

of making good under the warranty products sold before the end of the reporting period

Discussion 2 – Contaminated land – legislation virtually certain to be enacted An entity in the oil industry causes contamination

but cleans up only when required to do so under the laws of the particular country in which it operates. One country in which it operates has had no legislation requiring cleaning up, and the entity has been contaminating land in that country for several years. At 31st March 2009 it is virtually certain that a draft law requiring clean-up of land already contaminated will be enacted shortly after the year-end.

D2 – Contaminated land – legislation virtually certain to be enacted - Solution Present obligation as a result of a past obligating

event: The obligating event is the contamination of the land

because of the virtual certainty of legislation requiring clean-up

An outflow of resources embodying economic benefits in settlement: Probable


of the clean-up.

Discussion 3 – Contaminated land and constructive obligation An entity in the oil industry causes

contamination and operates in a country where there is no environment legislation. However, the entity has a widely published environmental policy in which it undertakes to clean up all contamination that it causes. The entity has a record of honouring this published policy.

D3 – Contaminated land and constructive obligation Present obligation as a result of a past obligating

event: The obligating event is the contamination of the land, which

gives rise to a constructive obligation because the conduct of the entity has created a valid expectation on the part of those effected by it that the entity will clean up contamination.



of the clean-up.

Discussion 4 – Offshore oilfield An entity operates an offshore oilfield where

its licensing agreement requires it to remove the oil rig at the end of production and restore the seabed. Ninety percent of the eventual costs relate to the removal of the oil rig and restoration of damage caused by building it, and ten percent arise through the extraction of oil. At the end of the reporting period, the rig has been constructed but no oil has been extracted.

D 4 – Offshore oilfield

Present obligation as a result of a past obligating event: The construction of the oil rig creates a legal obligation under the

terms of the license to remove the rig and restore the seabed and is thus an obligating event. At the end of the reporting period, however, there is no obligation to rectify the damage that will be caused by extraction of oil.


Conclusion A provision is recognized for the best estimate of 90% of the

eventual costs that relate to the removal of the oil rig and restoration of damage caused by building it. These costs are included as part of the cost of the oil rig. The 10% of costs that arise through the extraction of oil are recognized as a liability when the oil is extracted.

Discussion 5 – Refunds Policy

A retail store has a policy of refunding purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.

D 5 – Refunds Policy

Present obligation as a result of a past obligating event: The obligating event is the sale of the product, which gives

rise to a constructive obligation because the conduct of the store has created a valid expectation on the part of its customers that the store will refund purchases



of refunds

Discussion 6 – A court case

After a wedding in 2007, ten people died, possibly as a result of food poisoning from products sold by the entity. Legal proceedings are started seeking damages from the entity but it disputes liability. Up to the date of authorisation of the financial statements for the year to 31.03.2008 for issue, the entity’s lawyers advise that it is probable that the entity will not be found liable. However, when the entity prepares the financial statements for the year to 31.03.2009, its lawyers advise that, owing to developments in the case, it is probable that the entity will be found liable.

D 6 – A court case – At 31.03.2008 Present obligation as a result of a past

obligating event: On the basis of the evidence available when the

financial statements were approved, there is no obligation as a result of past events.

Conclusion: No provision is recognised. The matter is disclosed as a contingent liability

unless the probability of any outflow is regarded as remote

D 6 – A court case – At 31.03.2009 Present obligation as a result of a past

obligating event: On the basis of the evidence available, there is a

present obligation. An outflow of resources embodying economic

benefits in settlement: Probable.

Conclusion: A provision is recognised for the best estimate of

the amount to settle the obligation.

Discussion 7 – Refurbishment costs – no legislative requirement A furnace has a lining that needs to be

replaced every five years for technical reasons. At the end of the reporting period, the lining has been in use for three years.

D 7 – Refurbishment costs – no legislative requirement Present obligation as a result of a past obligating event:

There is no present obligation. Conclusion:

No provision is recognised The cost of replacing the lining is not recognised because,

at the end of the reporting period, no obligation to replace the lining exists independently of the company’s future actions—

even the intention to incur the expenditure depends on the company deciding to continue operating the furnace or to replace the lining.

Instead of a provision being recognised, the depreciation of the lining takes account of its consumption, ie it is depreciated over five years. The re-lining costs then incurred are capitalised with the consumption of each new lining shown by depreciation over the subsequent five years.

D 8 – Refurbishments costs – legislative requirement An airline is required by law to overhaul its

aircraft every three years.

Discussion 8 – Refurbishments costs – legislative requirement Present obligation as a result of a past obligating event:

There is no present obligation. Conclusion:

No provision is recognised. The costs of overhauling aircraft are not recognised as a

provision for the same reasons as the cost of replacing the lining is not recognised as a provision in preceding discussion.

Even a legal requirement to overhaul does not make the costs of overhaul a liability, because no obligation exists to overhaul the aircraft independently of the

entity’s future actions—the entity could avoid the future expenditure by its future actions, for example by selling the aircraft.

Instead of a provision being recognised, the depreciation of the aircraft takes account of the future incidence of maintenance costs, ie an amount equivalent to the expected maintenance costs is depreciated over three years.

Disclosures

For each class of provision, an entity shall disclose: the carrying amount at the beginning and end of the period; additional provisions made in the period, including

increases to existing provisions; amounts used (ie incurred and charged against the

provision) during the period ; unused amounts reversed during the period ; and 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.

Comparative information is not required.

Disclosures - contd

An entity shall also disclose the following for each class of provision: a brief description of the nature of the obligation and the

expected timing of any resulting outflows of economic benefits;

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; and

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

Contingent Liabilities

Contingent Liabilities

Definition

A contingent liability is 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 A present obligation that arises from past events but is not

recognized because: It is not probable that an outflow of resources embodying

economic benefits will be required to settle the obligation; or The amount of obligation cannot be measured with sufficient

reliability

Provisions v Contingent Liabilities Both are uncertain in timing or amount Contingent liability is dependant on

occurrence or non-occurrence of one / more uncertain future events not in control of entity

Recognition

An entity shall not recognize a contingent liability

Disclosures

Unless the possibility of any outflow in settlement is remote,

an entity shall disclose for each class of contingent liability at the end of the reporting period

a brief description of the nature of the contingent liability and, where practicable: an estimate of its financial effect; an indication of the uncertainties relating to the amount or

timing of any outflow; and the possibility of any reimbursement.

Contingent Assets

Contingent Assets

Definition

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

Recognition

An entity shall not recognize a contingent asset

Disclosures

Where an inflow of economic benefits is probable, an entity shall disclose a brief description of the nature of the contingent

assets at the end of the reporting period, and, where practicable, an estimate of their financial

effect. It is important that disclosures for contingent assets

avoid giving misleading indications of the likelihood of income arising.

Thank You

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IFRIC 1

Scope

Changes in measurement of any existing decommissioning, restoration or similar liability that is Recognized as part of the cost of PPE – as per

IAS 16 Recognized as a liability – as per IAS 37

Cost Model

Add / deduct to carrying amount Test for impairment – if add to carrying

amount

Revaluation Model

Adjust from Revaluation Surplus Any excess / deficit to PL

Unwinding of Discount

Finance Cost Recognize in PL