1. Provisions, contingent assets and contingent liabilities – IAS 37
Week 5
MN20018

2. Off Balance Sheet Financing – Substance over Form
Has a transaction occurred
Giving rise to a new asset or liability
Giving rise to a change in an existing asset or liability
Rights
Access to benefits
Evidenced by exposure to risks
Likelihood of risks arising

3. Substance over form Typical examples: Consignment stocks
Sale and repurchase agreements
Debt factoring

4. Consignment stocks Legal title retained by consignor
Consider economic risks and benefits
Likelihood of stock being returned
Past experience
Contractual penalty clauses

5. Sale and repurchase agreements
Vendor retains control of the asset
Asset remains in use
Substance not that of normal sale
Retain on balance sheet of vendor

6. Sale and repurchase agreements
Substance is that of finance arrangement
Money borrowed on security of asset
Repurchase amount will include interest
Separate out the interest element
Report interest in Income Statement
Report as a liability in the balance sheet

7. Debt factoring Factoring may be: Without recourse Or With recourse
Sale of debts without recourse
Any bad debts are suffered by factor
Treat cash received from factor as settlement of debts

8. Provisions & Contingencies
Affect income statement & balance sheet
Contingencies
No affect
Can be disclosed as note
May not even be disclosed at all
Liability of uncertain timing or amount
Increase in provision recognised in IS as expense
Liability created
Provisions are by nature uncertain so
Timing and amount has to be estimated

9. Recognition Used to be able to use provisions to manipulate accounts
Eg loss making business creating provision to cause large loss in 1 year
Gradually reduce provision in subsequent years to offset losses/show profits
IAS 37 prevents this
Company should have present obligation arising from past event
Must be probable an outflow of resources embodying economic benefits will be required to clear the obligation
Probable = more likely than not to occur
Group of small obligations can be lumped together as a class of obligations
Should be reliable estimate of amount of obligation

10. Non-recognition Provision not recognised unless
Obligatory event exists – present obligation from past event
Settlement of obligation is legally enforceable
Eg obligation to make good environmental damage
Constructive obligation – event creates valid expectation in 3rd party
Eg a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period
Or decommissioning nuclear power stations

11. Measurement & Review Measurement of provision =
Best estimate of expenditure required
Amount should be estimate before tax
If large number of events – expected value based on range of outcomes & probabilities
Should take account of risks & uncertainties but not use excessive prudence & overstate provisions
Reviewing provision
At every balance sheet date & adjust to reflect best current estimate
If provision is long-term & time value of money is material - should be stated at present value

12. Specific applications - 1
Future operating losses
Cannot create provision for this – no obligating event & no present obligation
Specifically outlawed by IAS 37
Onerous contracts
Unavoidable costs of meting contract are > than expected economic benefits
Provision should be recognised
Lowest cost of exiting contract
Ie cost of carrying out contract or
Cost of penalty for failure to complete contract

13. Specific applications - 2
Restructuring costs
Incurred when company
Sells/closes line of business
Closes business location in a country/region of another country
Changes management structure substantially
Carries out fundamental reorganisation materially affecting nature/focus of operations
Provision for restructuring costs only allowed if recognition criteria apply
i.e. Detailed & formal plan of restructuring exists outlining expected number/location of employees to be compensated, expenditures to be undertaken & timing of them
Should have raised expectation in individuals affected that reorganisation will occur

14. Contingent liabilities
Possible obligations that arise from past events & whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events that are not wholly within the company’s control
Or present an obligation arising out of past events that is not recognised as a provision because
Not probable outflow of resources needed to settle obligation
Obligation cannot be measured satisfactorily

15. Contingent liabilities
So contingent liability is
Possible obligation not yet confirmed
Present obligation that does not meet all criteria for recognition as a provision
Therefore not recognised as liability
If CL is not remote - possibility disclose as note
If CL is remote - do not disclose

16. Contingent Asset
Arises from past events but its existence confirmed by occurrence/non-occurrence of uncertain future events not in the company’s control.
Eg compensation from a law suit
Do not recognise as an asset
When realisation of income/asset become virtually certain then recognise

17. Disclosures Reconciliation for each class of provision:
Opening balance
Additions
Used (amounts charged against the provision)
Released (reversed)
Unwinding of the discount
Closing balance
A prior year reconciliation is not required
For each class of provision, a brief description of:
Nature
Timing
Uncertainties
Assumptions
Reimbursement

18. Post balance sheet events – IAS 10
Events which could be favourable or unfavourable that occur after the balance sheet date but before accounts are authorised
2 types of events…
Adjusting event: An event after the balance sheet date that provides further evidence of conditions that existed at the balance sheet
including an event that indicates that the going concern assumption in relation to the whole or part of the enterprise is not appropriate.
Non-adjusting event: An event after the balance sheet date that is indicative of a condition that arose after the balance sheet date.

19. Treatment Adjust financial statements for adjusting events
Do not adjust for non-adjusting events
If an entity declares dividends after the balance sheet date, the entity shall not recognise those dividends as a liability at the balance sheet date
That is a non-adjusting event

20. Going Concern Issues Arising After Balance Sheet Date
An entity shall not prepare its financial statements on a going concern basis if management determines after the balance sheet date either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so

21. Disclosure
Non-adjusting events should be disclosed if they are of such importance that non-disclosure would affect the ability of users to make proper evaluations and decisions
Required disclosure is
the nature of the event and
an estimate of its financial effect or a statement that a reasonable estimate of the effect cannot be made

22. Disclosure
A company should update disclosures that relate to conditions that existed at the balance sheet date to reflect any new information that it receives after the balance sheet date about those conditions.
Companies must disclose the date when the financial statements were authorised for issue and who gave that authorisation
If the enterprise's owners or others have the power to amend the financial statements after issuance the enterprise must disclose that fact

23. IAS 24 - Related party disclosures
Objective of IAS 24
To ensure that an entity's financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances with such parties

24. Who Are Related Parties?
Parties are considered to be related if
one party has the ability to control the other party or
to exercise significant influence or joint control over the other party in making financial and operating decisions

25. Related Entity A party is related to an entity if:
(a) directly, or indirectly through one or more intermediaries, the party:
(i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries)
(ii) has an interest in the entity that gives it significant influence over the entity or
(iii) has joint control over the entity
(b) the party is an associate of the entity
(c) the party is a joint venture in which the entity is a venturer

26. Related Entity A party is related to an entity if:
(d) the party is a member of the key management personnel of the entity or its parent
(e) the party is a close member of the family of any individual referred to in (a) or (d)
(f) the party is an entity that is controlled, jointly controlled or significantly influenced by or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e) or
(g) the party is a post-employment benefit plan for the benefit of employees of the entity, or of any entity that is a related party of the entity

27. Not related Examples where a party is not related:
two enterprises simply because they have a director or key manager in common
two venturers who share joint control over a joint venture
providers of finance, trade unions, public utilities, government departments and agencies in the course of their normal dealings with an enterprise
a single customer, supplier, franchiser, distributor, or general agent with whom an enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence

28. Related Party Transactions
A related party transaction is a transfer of resources
services or
obligations
between related parties regardless of whether a price is charged

29. Disclosure The amount of the transactions.
The amount of outstanding balances, including terms and conditions and guarantees
Provisions for doubtful debts related to the amount of outstanding balances
Expense recognised during the period in respect of bad or doubtful debts due from related parties

30. Types of transactions that would be disclosed if they are with a related party
Purchases or sales of goods
Purchases or sales of property and other assets
Rendering or receiving of services
Leases
Transfers of research and development
Transfers under licence agreements
Transfers under finance arrangements (including loans and equity contributions in cash or in kind)
Provision of guarantees or collateral
Settlement of liabilities on behalf of the entity or by the entity on behalf of another party

31. IAS 32 – Financial Instruments – Disclosure & Presentation Objective of the standard
Objective to enhance financial statement users' understanding of the significance of financial instruments to an entity's financial position, performance, and cash flows
Does so by
Clarifying the classification of a financial instrument issued by an enterprise as a liability or as equity
Prescribing the accounting for treasury shares (a company's own repurchased shares)
Prescribing strict conditions under which assets and liabilities may be offset in the balance sheet
Requiring a broad range of disclosures about financial instruments, including information as to their fair values

32. No-one here just us shares
We will deal with SHARES only
When a company issues a financial instrument it should classify as
Financial Liability (sometimes asset)
Equity
Equity Instruments
Ordinary shares
Some preference shares
Share warrants (right to purchase shares in future at fixed price)
Financial Liabilities
Trade payables
Bank loans
Bonds (loan stock/debentures)

33. and preference shares Preferences shares
Entitle shareholder to a dividend before ordinary shareholders
Usually fixed amount
Redeemable
Irredeemable

34. Equity or financial liability? Or both (compound financial instrument)
Key factor – extent to which company obliged to make future repayments
Required to redeem share = future obligation
redeemable element = financial liability
dividends = financial liability or deduction of equity
Cumulative shares
dividend element = financial liability
Irredeemable non-cumulative = Equity
Convertible bonds have 2 elements
Financial liability + equity – therefore compound financial instrument

35. Compound instruments illustration
Convertible debentures
1 January 20X0 1,000 £100 5% issued at par
1 January 20X5 Convert into 50 ordinary shares
per £100 OR redeem at par
Interest rate on similar debentures is 6%

36. Compound instruments illustration
Value of debt
Present value of redemption payment £74,726
Present value of interest (5 years) £21,062
Value of debt £95,788
Value of equity proceeds £ 4,212
Par value £100,000

37. Interest, dividends, gains & losses
All 4 relating to a financial liability should be recognised as an expense (in IS)
Dividends to equity shareholders debit directly to equity
Transaction costs of equity transactions = debit to equity net of tax benefit
Note divis recognised in Fin Statements as deduction from equity only
If dividend paid
before BS date
since previous BS date

38. Distributable Profit
Profits not distributed until profit/gain realised
If company makes a loss should be allowed to pay divis if has sufficient accumulated profits
Capital from shareholders is not distributable
Reserves
Capital reserves not distributable (revaluation reserve/share premium)
Revenue reserves are distributable

39. Share issues Share issues
Increase cash/bank/assets by cash raised less issue costs
Share capital increased by nominal value of shares
Share premium increased by cash raised – par value – issue costs
Bonus issue
In bonus issue
Company converts some reserves to share capital
Issues new shares to existing share holders in proportion to existing shareholdings
If there is share premium it can be reduced
If not (or insufficient) use reserves

40. Own share buy back - 1 Can repurchase own shares and cancel them
But creditors must be protected
Therefore: transfer from accumulated profit to capital reserves….
Purchase cost of shares
DR CR
Par value share capital Bank
Share premium
Accumulated profit
Capital maintenance
Accumulated profit Capital reserves

41. Own share buy back - 2 As purchase price probably > par value
Dr excess top share premium, but restricted to lowest of 3 amounts
share premium originally received when shares issued
current balance on share premium
actual premium on redemption
Transfer to capital reserve = par value of shares purchased + cancelled
If repurchase financed by new issue of preference shares treated as equity
Transfer to capital reserve reduced by mount of new shares issued

42. Redeemable shares As company under obligation to buy back in future
Obligation = financial liability