Objective of the Standard
The objective of this standard is to provide guidance with regards to the recognition criteria and basis for measurement when accounting for any provision, contingent liability and contingent asset and also to make sure that sufficient information regarding timing and nature of the events involving such items are disclosed on timely basis.
Scope of the Standard
This standard applies to all type of Provision, contingent liabilities and contingent assets except than:
• Those covered by any other standard like IFRS 9 covers financial instrument’s recognition and measurement. Like IAS 11 covers construction contract related provisions. IAS 12 covers income taxation and deferred taxation related provisions. IAS 19 is applicable to Employee benefit obligations and IFRS 4 covers all the obligations associated with an insurance contract.
• Any provision or liability arising from non-onerous executory contracts is not covered by this standard.
This standard is applicable only to onerous lease contracts and onerous executory contracts.
Onerous contract is a contract in which unavoidable costs of fulfilling the obligation under the contract exceeds the economic benefits that are expected from that contract.
IAS 37 does not anyhow define the recognition of any revenue related to any provision. If any company is charging fee in exchange of guarantee then that revenue will be recognized under IAS 18 or IFRS 16 in accordance with the revenue recognition criteria.
Definition of Provision
Provision can be defined as a liability, the timing or amount of which is uncertain.. However, this standard does not cover provisions related to doubtful debts or impairment indication of assets. However, this standard is applied to provision for restructuring and discontinued assets.
A restructuring is a process controlled by the management of the business that will change the scope of the business or the process of conducting the business.
Definition of Liability
A liability can be defined as a Present obligation that arises due to past events and as a result of which the outflow of economic resources from the entity is expected in the future.
An obligating event is an event that creates legal or constructive obligation that will result in an entity having to settle that obligation by transferring economic resources to the other party to the obligating event in the future.
A legal obligation results due to:
• Explicit or implied contract
• Or any other operation of the law
A constructive obligation is resulted from the actions of entity where:
• By an entity’s past practices or customs, published policies of the business or announcements and commitments made to certain parties.
• As a result of the expectations made by the entity on part of those entities who are not going to fulfil this commitment.
It is a possible obligation that arises as a result past events/ transactions and the existence of this obligation will only be confirmed by the occurrence or non-occurrence of certain relevant events in the future and these events are not in the control of entity.
This obligation will only be recognized if:
• It is probable that there will be economic outflow due to existence of this obligation.
• The amount of the obligation can be measured reliably.
Contingent liability is disclosed as per the standard unless the chances of economic outflow are remote then it won’t be disclosed. Therefore, contingent liability is assessed continually to make sure that if economic outflow chances are probable and if chances are probable now then it would be recognized as provision in the financial statements.
It is a possible asset that arises from the past events and the existence of this asset will only be confirmed by the occurrence or non-occurrence of certain relevant events in the future and the entity has no control over such events.
Contingent assets are not recognized in the financial statements as it may result in recognition of income that would never be realised. So, if realisation of income is certain then contingent assets recognition is appropriate. When economic benefit inflow is probable then contingent asset will be disclosed in the entity’s financial reports. Contingent assets are assessed continually to make sure that if income realisation is certain then it would be recognized in that relevant period’s financial statements.
Relationship between provision, other liabilities and contingent liabilities
Provision is totally different from other liabilities like trade creditors or accrued expenses. In provision, there is uncertainty about the amount and timing of the obligation.
However, in trade creditors there is a proper agreed bill with the supplier that will be paid in the future and that is used to record the liability of that event. In accruals, services or goods are received but expense is not charged as payment is not processed. There is some uncertainty about the timing of the event but that uncertainty is much less than the provision.
Provision and contingent liabilities both are uncertain but contingent liabilities do not meet the recognition criteria as the existence of that obligation will only be confirmed by the occurrence or non-occurrence of certain events in the future. In provisions, it is confirmed that entity has obligation of economic outflow but on the other side in the contingent liabilities it is uncertain that if there will be an economic outflow obligation.
Recognition of Provision
A provision will be recognized if:
• Entity has a present obligation due to past events
• Future economic outflow to fulfil that obligation is probable
• Obligation can be measured reliably
At the end of the reporting period, after considering all the evidences it would be clear that if entity has present obligation or not. If it is clear that there is obligation then provision will be recorded. If there is not sufficient evidence then contingent liability will be disclosed unless the chances of future economic outflow are remote.
Financial statements manage the financial position of an entity at the end of its reporting period and not its conceivable position later on. In this way, no provision arrangement is perceived for costs that should be incurred to operate in the future. The main liabilities perceived in an entity’s financial position are those that exist at the end of the current reporting period.
An obligation dependably includes another party to whom the commitment is owed. However to know the identity of the other party is not required as that commitment might be to the general public. Since an obligation dependably includes a promise to another party, it follows that a management or board decision does not give rise to a constructive obligation at the end of the reporting period unless the decision has been communicated before the end of the reporting period to those affected by it in an adequately particular way to bring a legitimate desire up in them that the entity will release its obligations.
An event that does not give rise to an obligation immediately may do so later because laws of the country can be changed like if there is no environmental protection law then maybe in the future approval of relevant legislation can result in obligation for the entity so it should be considered appropriately. Provision will be resulted in probable chances of approval of the law.
Management should make sure that amount recognized as provision should be the best estimate to present true and fair view of the financial statements. Provision can be estimated on the basis of best management judgement, reports from external advisors or past similar experiences. Judgement is estimated by considering all possible outcomes and possibilities.
(E.g. In a court case, a professional lawyer can help the management to judge the best estimate for a provision of damages payable in case of unfavourable judgement of the lawsuit.)
Risk and uncertainties should be considered for reaching the outcome of estimate. Risk depends on the chances of the outcome. Highly skilled judgement is needed otherwise expenses can be overstated or understated. Relevant disclosure about the uncertainty of provision will be made in the financial statements.
When the time value of money has a material effect on the value of the provision then the provision value should be the value of the expenses expected to be paid to settle the obligation in the future. Other than this, future events will also be considered for the provision.
(E.g. cleaning a site in current time can be costly. In future if there is expected to be a new technology that can save costs then this future event will be considered for the estimate and if the amount is material then also it will be adjusted as per time value of money.)
Any gain from the expected disposal of an asset cannot be considered for the provision estimate. If there are some chances that provision will be reimbursed by the other party in the future then it can only be recognized as a separate asset if this is virtually certain. In profit & loss, expense related to provision can be presented net of the amount recognized for a reimbursement. Provision cannot be recognized for the future operating losses.
Following situations can be described as restructuring of the business:
• Sale or termination of a business line or segment
• Closure of business branches in a country or relocation to new country
• Changes in management layered structure
• Fundamental reorganisations having material effect on entity’s operations
Constructive obligation can only arise for restructuring when:
• Management has a detailed plan for restructuring containing at least:
– The relevant and concerned business part
– Affected business locations
– Approximate number of employees to be terminated for this restructuring
– When plan will be implemented
– Associated costs with the implementation of this plan
• Entity has raised a valid expectation that restructuring will be carried out and formal plan is announced for the effects of this operation
No provision with regards to restructuring will be recognized until the plan of restructuring has officially been announced or the management has started implementing the plan.
Restructuring provision should only include the direct expenditure related to that provision:
• Necessarily incurred by the restructuring entity as part of the restructuring process
• Not associated with other on-going activities of the entity
An entity should disclose the following with regards to a provision:
• The carrying value at the start of the period
• Any additional provision made in the period
• Amount charged against the provision in the period
• Any discounts on provision for passage of time or change in the discount rate
• A detailed description for the obligation nature and timings
• Indications about the timing and amount of the outflows
• If any reimbursement is expected
The entity is also required to give the following disclosures with regards to a contingent liability:
• The details of the uncertainties associated with a contingent liability
• The details of any reimbursement associated with the contingent liability
The entity is also required to give disclosures about a contingent asset if the economic benefits inflow is probable.