1. Provisions, Contingent Liabilities and Contingent Assets: IAS 37
Wiecek and Young
IFRS Primer
Chapter 5

2. Provisions, Contingent Liabilities and Contingent Assets
Related standards
IAS 37
Current GAAP comparisons
Looking ahead
End-of-chapter practice

3. Related Standards FAS 5 Accounting for Contingencies
FAS 143 Accounting for Asset Retirement Obligations
FAS 146 Accounting for Costs Associated with Exit or Disposal Activities
CON 5 Recognition and Measurement in Financial Statements of Business Enterprises
CON 6 Elements of Financial Statements
CON 7 Using Cash Flow Information and Present Value in Accounting Measurements

4. Related Standards
Framework for the Preparation and Presentation of Financial Statements
IFRS 4 Insurance Contracts
IAS 1 Presentation of Financial Statements
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 17 Leases
IAS 19 Employee Benefits

5. IAS 37 – Overview Objective and scope Recognition Measurement
Reimbursements
Changes in and use of provisions
Application of the recognition and measurement rules
Disclosures

6. IAS 37 – Objective and Scope
Standard seeks to ensure that provisions and contingencies are appropriately dealt with in terms of recognition, measurement, and disclosure
It does not cover:
Executory contracts unless they are onerous
Provisions or contingencies that are covered by other standards
Depreciation and impairments
The key thing that separates a provision from other liabilities is the uncertainty associated with it, including:
• Uncertainty of the timing of a future expenditure, and/or
• Uncertainty of measurement

7. IAS 37 – Objective and Scope
The standard defines provisions, contingent liabilities, and contingent assets as follows:
A provision is a liability of uncertain timing or amount
A contingent liability is
(a) 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
(b) A present obligation that arises from past events but is not recognized because
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or
(ii) the amount of the obligation cannot be measured with sufficient reliability
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

8. IAS 37 – Objective and Scope
How are provisions differentiated from contingencies?
Both have significant uncertainty associated with them, although contingencies have considerably more - relating either to the outcome of a future event or the measurement of the element
The terms contingent assets/liabilities are used to refer to assets/liabilities that are not recognized in the financial statements because of significant uncertainty
Provisions, by contrast, are recognized. They reflect an existing obligation that is measurable and probable

9. IAS 37 – Recognition PROVISIONS:
Provisions are recognized only when all of the following criteria are met:
(a) An entity has a present obligation (legal or constructive) as a result of a past event
(b) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and
(c) A reliable estimate can be made of the amount of the obligation
The above definition is essentially the definition of a liability, including
recognition criteria

10. IAS 37 – Recognition
Present Obligation Resulting from a Past Event, Which Is Independent of
an Entity’s Future Actions
To determine whether we should recognize a liability or not depends on whether an obligation exists at the present time
This is differentiated from a future commitment, although the latter may create a present obligation if there are significant negative consequences
The obligation must also result from a past event (sometimes referred to as an obligating event) and according to IAS 37.17, there is no realistic alternative to settling the obligation (there is little or no discretion to avoid settlement)
The standard notes that this would be the case, for instance:
• Where the obligation is enforceable by law (known as a legal obligation), or
• Where a valid expectation has been created that the entity will discharge the
obligation (known as a constructive obligation)

11. IAS 37 – Recognition
Constructive and legal obligations are specifically defined as follows:
A constructive obligation is an obligation that derives from an entity’s actions where:
(a) 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
(b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities
A legal obligation is an obligation that derives from:
(a) A contract (through its explicit or implicit terms)
(b) Legislation or
(c) Other operation of law.
An entity should take care to avoid accruing provisions for things that it can
avoid through future actions

12. IAS 37 – Recognition

13. IAS 37 – Recognition
Probable Outflow of Resources Embodying Economic Benefits
For recognition, the potential outflow of resources must be probable (more likely than not)
If it is not probable, then note disclosure is required, unless the probability is remote
Reliable Estimates of an Obligation
Provisions, by definition, are very uncertain and therefore may be difficult to measure
In general, the standard presumes that the entity should be able to determine a reliable range of outcomes; however, if the provision is not estimable (in rare situations), then note disclosure is required
CONTINGENT LIABILITIES AND ASSETS:
Note disclosure only, unless the probability of occurrence is remote, in which case note disclosure is not required

14. IAS 37 – Measurement BEST ESTIMATE AND RISKS/UNCERTAINTIES:
According to IAS 37, an entity must accrue the best estimate of the amount for the provision
Best estimate is defined as follows:
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
Entities must gather evidence to support the assessment of best estimate, which may require market data and the use of independent experts

15. IAS 37 – Measurement
There are differing methodologies for measuring the provision, and the technique chosen depends upon the nature of the item that the provision relates to

16. IAS 37 – Measurement PRESENT VALUE:
Where the time value is material, the present value of the cash flows must be used in estimating the amount
The discount rate shall
Be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability
Not reflect risks for which future cash flow estimates have been adjusted
Since IAS 37 gives little guidance as to how to discount, the following approaches would be acceptable:
1. Adjust the discount rate to reflect the riskiness of the cash flows
This is sometimes referred to as the traditional present value technique or a discount rate adjusted approach
2. Use a risk-free rate as the discount rate but consider multiple cash flow scenarios that reflect differing outcomes and their probability of occurrence
This method is referred to as the expected present value technique

17. IAS 37 – Measurement
Either the discount rate or the cash flows are adjusted for risk but not both
Recall that IAS 37 gives little guidance and thus leaves it to professional judgment

18. IAS 37 – Measurement FUTURE EVENTS: EXPECTED DISPOSAL OF ASSETS:
In estimating the provision, entities may consider future events if there is sufficient evidence regarding the occurrence of the events
EXPECTED DISPOSAL OF ASSETS:
No gains are taken into income for assets that are expected to be sold
Since they are not realized

19. IAS 37 – Reimbursements
In some cases, some of the cash outflows will be reimbursed
This should be assessed separately and recognized when the receipt of cash inflows is virtually certain
In terms of presentation, the cost and the reimbursement may be offset in the statement of profit and loss

20. IAS 37 – Changes In and Use of Provisions
The provisions should be continually assessed, at a minimum, at the end of each reporting period
If the amount of the provision is discounted, then borrowing costs are recognized

21. IAS 37 – Application of the Recognition and Measurement Rules
FUTURE OPERATING LOSSES:
Future operating losses are not accrued since they represent future events that an entity may be able to get out of
However, future losses may be indicative of asset impairment
ONEROUS CONTRACTS:
According to IAS 37.10, an onerous contract is
“. . . a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it”
Present obligations under onerous contracts are recognized as provisions in the financial statements
Onerous contracts are often purchase commitments, where the entity is locked in and must settle the contract according to terms that are unfavourable to it

22. IAS 37 – Application of the Recognition and Measurement Rules

23. IAS 37 – Application of the Recognition and Measurement Rules
RESTRUCTURING:
Restructuring includes termination of a line of business, closure or relocation of business, changes in management structure, and fundamental reorganizations
As a general rule, a restructuring provision should be recognized when the criteria for recognizing a provision is met:
• The entity has a present obligation (legal or constructive) as a result of a past event
• It is probable that an outflow of resources will be necessary to settle the obligation and
• The restructuring is measurable (a reliable estimate can be made)

24. IAS 37 – Application of the Recognition and Measurement Rules
Additionally, the following criteria must also be met in order to argue that a constructive obligation exists:
(a) [The entity] has a detailed formal plan for the restructuring, identifying at least
(i) The business or part of a business concerned
(ii) The principal locations affected
(iii) The location, function, and approximate number of employees who will be compensated for terminating their services
(iv) The expenditures that will be undertaken and
(v) When the plan will be implemented and
(b) [The entity] has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it
The provision under the standard includes only direct costs that meet both of the following criteria:
• The costs are necessarily entailed by the restructuring, and
• They are not associated with the ongoing activities of the entity

25. IAS 37 – Disclosures
Appropriate detail regarding the nature of the provisions and uncertainties should be disclosed
In rare cases where the information to be disclosed may prejudice the outcome of a dispute with other parties, there is not a requirement to disclose, other than the general nature of the dispute and the reason why full disclosure is not being made

26. Current GAAP Comparisons
Pages 90 & 100 of

27. Looking Ahead
The IASB originally decided to review IAS 37 as part of its short-term convergence project with FASB
It became apparent that the issues being discussed were quite foundational in terms of the entire body of knowledge
The IASB issued an Exposure Draft in 2005 and plans to issue a new standard in 2009
The standard proposes that all liabilities be recognized unless they cannot be reliably measured, and that uncertainty relating to the amount and timing of cash flows be reflected in the measurement of the liability

28. Looking Ahead
Some of the items being proposed/clarified are as follows:
1. Scope: Performance obligations will not be covered by the standard
2. Definitions:
Provision will not be a defined term due to its ambiguity
The terms contingent liability and assets will be deleted
Differentiation of a business risk from a present obligation will be more explicit
3. Recognition: Probability recognition criteria will be deleted
4. Measurement: More guidance on measuring expected values and reimbursement rights will be included

29. End-of-Chapter Practice
5-1 The concept of contingency is different under IFRS.
Instructions
Contrast and compare the definitions of contingencies and contingent liabilities under both IFRS and U.S. GAAP. How does the accounting differ? Start by looking up the respective definitions under the respective standards.

30. End-of-Chapter Practice

31. End-of-Chapter Practice

32. End-of-Chapter Practice

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