1. Provisions, Contingent Liabilities and Contingent Assets
Beverly Nielsen
Laura Bopp
Magan Berman

2. Definition of a Provision
The Conceptual Framework defines a liability as:
a present obligation
arising from a past event
that is expected to result in an outflow of economic resources
A provision is a subset of liabilities, defined in IAS 37 as
a liability of uncertain timing or amount
A present obligation exists only where the entity has no reasonable alternative but to settle the obligation

3. Introduction to IAS 37
IAS 37 addresses the recognition, measurement and presentation of:
Provisions (excluding those covered by another IAS)
Contingent assets and liabilities
Restructuring provisions
Onerous contracts

4. Contingency differences
Executive Summary
Contingency differences
IFRS
US GAAP
Standard
IAS 37, Provisions, Contingent Liabilities and Contingent Assets
ASC 450, Contingencies
Definition of probable
More likely than not
Likely
Amount of range of outcomes
Midpoint in range
Minimum in range
Discounting
Requires that the liability be discounted
Generally does not allow discounting 4

5. Present Obligation A present obligation may be:
Legal – arising from a contract
Equitable – arising from normal business practice or custom
Constructive – arising from established pattern of past practice
A present obligation exists only where the entity has no realistic alternative but to make the sacrifice of economic benefits to settle the obligation

6. Distinguishing Provisions From Other Liabilities
Key distinguishing factor is the uncertainty relating to either the timing or the amount
Typical provisions :
Warranty
Restructuring
Onerous contracts
Employee benefits are not provisions under IAS 37

7. Contingent Liabilities
Contingent liabilities are either:
(a) A possible obligation whose existence will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly in control of the entity
eg. a guarantee on a loan for another entity
OR…

8. Contingent Liabilities
(b) A present obligation that fails the recognition criteria because:
it is not probable an outflow of resources will be required to settle the obligation or
the amount cannot be measured reliably
eg. a lawsuit where amount of damages is uncertain
Contingent liabilities are not recognized in the financial statements but must be disclosed in the notes to the financial statements

9. Contingent Liabilities Guidelines
Outcome
Probability
Accounting Treatment
Virtually certain
At least 90%
Report as liability (provision)
Probable (more likely than not)
51-89% probable
Possible but not probable
5-50%
Disclosure required
Remote
Less than 5%
No disclosure required
Illustration 13-16, Intermediate Accounting IFRS Edition, Wiley, 2nd edition

10. Disclosure IAS 37 paras 84- 92 outline the disclosure requirements
Disclosure for each class of provision required
Disclosure for each class of contingent liability required
Disclosure of nature of contingent assets
Exemptions permitted in rare cases (para 92)
Many analysts consider the contingent liabilities note to be one of the most important

11. Decision Tree

12. Contingent Assets
Possible asset arising from a past event whose existence will be confirmed by the occurrence/non-occurrence of one or more uncertain future events not within the control of the entity
Contingent assets are not recognized in the statement of financial position but must be disclosed in the notes to the financial statements where an inflow of benefits is probable

13. Recognition Criteria For Provisions
Three criteria:
Present obligation as a result of a past event
Probable outflow of resources to settle
Amount of obligation can be reliably estimated

14. Measurement of Provisions
“Best estimate” of provision amount recognized
Requires professional judgements
Is calculated using ‘expected value’ estimation
Measured before tax
Estimates should be discounted to present value where material

15. Contingencies Loss Contingency – Definition of Probable and Range
US GAAP
Defines probable as “likely” (this has been generally interpreted as greater than a 70% chance of occurring)
Where there is a continuous range of possible outcomes and each point in the range is as likely as any other to occur, under ASC , the minimum amount in the range is used to measure the provision.
IFRS
Probable is defined as “more likely than not” (more than a 50% chance of occurring).
The midpoint of the range is used to measure the provision. 15

16. Range of Possible Outcomes Example
Example 1: An entity sells webcams with a warranty under which customers are covered for the cost of repairs of any manufacturing defects that become apparent within the first six months after purchase. The company has only recently started operations and thus cannot estimate what percentage of webcams will likely be returned. They do know that if defects were detected in all products sold, repair costs would range from $2 million for minor repairs to $4 million for major repairs.
Assuming all other criteria are met, how much should the entity book related to warranty repairs using US GAAP and IFRS?
Show any required journal entries. 16

17. Range of Possible Outcomes Example
Example 1 solution:
US GAAP
The minimum point of the range, $2.0 million, should be recorded.
Warranty expense $2,000,000
Warranty liability $2,000,000
IFRS
The midpoint of the range, $3.0 million, should be recorded.
Warranty expense $3,000,000
Warranty liability $3,000,000
Since the entity only had a range to work with, the treatment using the two sets of standards is different. If no particular outcome within the range is better than another, then for US GAAP the entity would book the minimum of the range, whereas for IFRS the entity would book the midpoint range. 17

18. Range of Possible Outcomes Example
Example 2: Use the same facts in example 1, except now assume the entity is able to perform an analysis on the historical data of returns and estimates (based on historical data), finding that 75% of the goods sold will have no defects, 20% of the goods sold will have minor defects and 5% of the goods sold will have major defects.
Assuming all other criteria are met, how much should the entity book related to warranty repairs using US GAAP and IFRS?
Show any required journal entries. 18

19. Probable Liability Example
Example 2 solution:
For both US GAAP and IFRS, $600,000 should be recorded. The most likely outcome is $600,000 explained as follows: (20% of $2 million for minor repairs = $400,000) + (5% of $4 million for major repairs = $200,000) + (75% without defects and, therefore, no impact on the estimate).
Warranty expense $600,000
Warranty liability $600,000 19

20. Measurement of Provisions
Should account for expected cash outflows only, disregarding any expected cash inflows
Reimbursements must be virtually certain (not just probable) to be recognized
Must review provisions at each end of reporting period

21. Definitions, Recognition & Measurement Rules
Future operating losses:
Excluded from the calculation of provisions
Onerous contracts:
Those that have more unavoidable cost than they expect the economic benefits to be
The present obligation under an onerous contract must be recognized as a provision
Find example for onerous contracts (page 620) 21

22. Definitions, Recognition & Measurement Rules
Restructuring provisions:
The most controversial aspect of IAS 37
Restructuring provisions can be recognized as part of an acquisition of another business (IFRS 3)
IAS 37 addresses non business combination restructuring

23. Restructuring Provisions
May occur due to:
Sale or termination of a line of business
The closure of business locations in a country region or relocation of business activities
Changes in the management structure
Fundamental reorganizations

24. Restructuring Provisions
Essential conditions to recognize a restructuring provision:
Must have a present obligation to restructure
Costs must be directly and necessarily caused by the restructuring
If the restructuring involves the sale of an operation, a binding sale agreement is needed

25. Restructuring Provisions – Present Obligation
Present obligation is considered to arise when the entity has a detailed plan identifying at least:
The business (or part thereof) concerned
The locations affected
The employees affected
The expenditures that will be undertaken
The timing of implementation

26. Restructuring Provisions – Present Obligation
Must have raised a valid expectation by those affected that it will carry out the plan by commencing restructuring or making an announcement to those affected
In the case of restructuring provisions arising as part of an acquisition of another business, the provisions must be recognized in the books of the acquiree

27. Restructuring Provisions – Qualifying Costs
Costs must be directly and necessarily caused by the restructuring and should not be associated with the ongoing operations
Examples of qualifying costs include:
The costs of terminating leases and other contracts
Costs associated with employees dismantling plant
Employee redundancy costs
Costs specifically excluded include:
Employee retraining and relocation costs
Marketing costs

28. Questions? The Future of IAS 37
2005: IAS 37 had a lot of proposed revisions
New definitions of contingencies
New recognition and measurement criteria
However, the revisions were not made
but they could in the future
Questions?