IAS 37 – PROVISIONS, CONTINGENT
LIABILITIES AND CONTINGENT ASSETS
OBJECTIVE
The
objective of IAS 37 is to ensure that appropriate recognition criteria and
measurement bases are applied to provisions, contingent liabilities and
contingent assets and their disclosures.
IAS
37 excludes obligations and contingencies arising from
1.
Financial instruments (IFRS 9)
2.
Non-onerous executory contracts
3.
Insurance contract
4.
Income taxes (IAS 12)
PROVISION
Provision
is a liability of uncertain timing
or amount.
Liability
is a
present obligation of the entity to transfer an economic resource as a result
of past events. Past events result into two types of obligation:
a. Legal obligation
This is
the obligation that arises from legislation, a contract or other legal act.
b. Constructive obligation
This is
the obligation that arises from customs or business practice and has created an
expectation in other parties to fulfill an obligation.
When to recognise a provision?
IAS 37
sets three criteria for recognizing a provision. These include:
1. There
must be a present obligation as a result of a past event.
2. The
outflow of economic benefits to satisfy the obligation must be probable (more
than 50% probable).
3. The
amount of economic benefits required to satisfy the obligation must be reliably
estimated.
Note: Recognise a provision if all
the three criteria are met. However, you should disclose a contingent liability
if just one of the criteria is not met.
How to measure a provision?
The
amount of the provision should be measured at the best estimate of the
expenditures required to satisfy the obligation at the end of the reporting
period.
The following
should be included in the estimate:
a. Risks
and uncertainties
b. Time
value of money
c. Some
probable future events
Methods of Measuring Provision
There
are two methods of measuring provision. These are
1. Expected value method
This is
the method of measuring provision in which there is a range of outcomes.
2. Most likely outcome
This is
the method of measuring provision in which there is just a single obligation.
How to Account for a Provision?
Accounting
treatments:
A. Recognition of provision
Debit
Profit or Loss (Expense)
Credit
Provision
B. Unwinding the discount
Debit
Profit or Loss (Finance cost)
Credit
Provision
C. Utilization of provision
Debit
Provision
Credit
Cashbook
PROVSISIONS IN SPECIFIC CIRCUMSTANCES
A. Future Operating Losses
DON’T make a provision for future
operating loss since there is no past event for future operating loss.
B. Onerous Contract
Onerous
contract is a contract in which unavoidable costs of fulfilling exceeds the
benefits from the contract.
The
measurement rule for onerous contract is lower of:
i.
unavoidable cost of fulfilling the contract
ii.
penalty for not meeting the obligations of the contract.
C. Restructuring
Restructuring
is a plan of management to change the scope of business or a manner of a
business.
A
provision for restructuring is only recognised when the general criteria for
provision are met.
Restructuring
arises when:
a.
there is a detailed formal plan for restructuring with the relevant information
in it.
b.
a valid expectation related to the restructuring has been raised in the
affected parties.
CONTINGENT LIABILITY
A
contingent liability is either:
1.
a possible obligation from past event that will be confirmed by some future
events, or
2.
a present obligation from past event but either the outflow of economic
benefits to satisfy the obligation is not probable (less than 50%) or the
amount of obligation cannot be reliably measured.
CONTINGENT ASSET
A
contingent asset is a possible asset arising from past events that will be
confirmed by some future events not fully under the entity’s control.
Note:
DON’T recognise
contingent liability or contingent asset in your financial statements. However,
one is expected to disclose them.
DISCLOSURES
DISCLOSURES RELATING TO PROVISIONS
1.
Disclosure of details of the change in carrying value of a provision from the
beginning to the end of the year.
2.
Disclosure of the background to making of the provision and the uncertainties
affecting its outcome.
DISCLOSURES RELATING TO CONTINGENT
LIABILITIES
An
entity should disclose
1.
a brief description of the nature of the contingent liability.
2.
an estimate of its financial effect.
3.
an indication of the uncertainties that exists.
4.
the possibility of any reimbursement.
DISCLOSURES RELATING TO CONTINGENT
ASSETS
An
entity should disclose
1.
a brief description of the nature of the contingent asset.
2.
an estimate of its financial effect.
3.
an indication of the uncertainties that exists.
4.
the possibility of any reimbursement.