IFRS 37 or IAS 37 Provisions, Contingent Liabilities and Contingent Assets
International Accounting Standard 37 or IFRS 37 defines the accounting and disclosure of provisions, contingent liabilities, and contingent assets.
A liability is a 'present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits'.
A provision is "a liability of uncertain timing or amount".
Recognition and initial measurement:
A provision is recognized when:
1. The entity has a present obligation as a result of past events;
2. It is probable (more likely than not) that a transfer of economic benefits will be required to settle the obligation; and,
3. A reliable estimate of the amount of the obligation can be made.
The recognized amount of provision is the best estimate of the expenditure required to settle the present obligation at the balance sheet date, measured at the present value of the expected cash outflows where the effect of the time value of money is material. Provisions are not recognized for future operating losses.
IAS 37 elaborates on the application of the recognition and measurement requirements for three specific cases:
· Future operating losses—a provision cannot be recognized because there is no obligation at the end of the reporting period;
· An onerous contract gives rise to a provision; and
· A provision for restructuring costs is recognized only when the entity has a constructive obligation because the main features of the detailed restructuring plan have been announced to those affected by it.
What is the present obligation?
A present obligation arises from an obligating event and may be either a legal obligation or a constructive obligation. An obligating event results in the entity to settle the obligation. If an entity can avoid future expenditure by its future actions, it has no present obligation, hence, and no provision is required. For example, an entity cannot recognize a provision based solely on the intent to incur the expenditure at some future date or the expectation of future operating losses.
An obligation does not have to be a 'legal' obligation before a provision is recognized. An entity may have an established pattern of past practice, published policies or a sufficiently specific current statement that indicates to other parties that it will accept certain responsibilities and as a result has created a valid expectation on the part of those other parties that it will discharge those responsibilities (that is, the entity has a constructive obligation).
If an entity has an onerous contract (the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it), the present obligation under the contract is recognized as a provision. Impairments of any assets dedicated to the contract are recognized before making a provision.
A restructuring provision is recognized only when the general recognition criteria for provision are met. The obligation for restructuring is often constructive. A constructive restructuring obligation arises only when there is:
(a) a detailed formal plan identifying the main features of the restructuring; and
(b) a valid expectation in those affected that the entity will carry out the restructuring by starting to implement the plan or announcing its main features to those affected.
A restructuring plan does not create a present obligation at the balance sheet date if it is announced after that date, even if it is announced before the financial statements are approved. A sale or termination of a business might fall under the definition of restructuring. No obligation arises in respect of restructuring costs associated with the sale of an operation until the entity is committed to the sale (that is, there is a binding sale agreement).
Restructuring provision includes only the direct expenditures arising from the restructuring, which are necessarily entailed by the restructuring and not those associated with the entity's ongoing activities. Any expected gains on the sale of assets are not considered in measuring a restructuring provision.
Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized only when it is virtually certain that reimbursement will be received if the entity settles the obligation. The entity typically remains liable for the entire obligation, and reimbursements are therefore presented separately as assets. The amount recognized should not exceed the amount of the related provision. Expenses relating to a provision can be presented net of the amount recognized for reimbursement in the income statement.
Provisions are reversed after the period end and re-assessed at the end of each reporting period and adjusted to reflect current best estimates. This re-assessment should include the estimated cash flows and the discount rate. The unwinding of the discount due to the passage of time should be included as an element of borrowing costs in arriving at profit or loss for the year.
Contingent liabilities refer to possible obligations that arise may from past events and whose existence will be confirmed only on the occurrence or non-occurrence of uncertain future events outside the entity's control, or present obligations that arise from past events but are not recognized because:
(a) it is not probable that an outflow of economic benefits will be required to settle the obligation; or
(b) the amount cannot be measured reliably.
Contingent liabilities are not recognized but are disclosed in notes to accounts unless the possibility of outflow is remote.
Contingent assets are probable assets that arise from past events and whose existence will be confirmed only on the occurrence or non-occurrence of uncertain future events outside the entity's control. Contingent assets are not recognized in the accounts but are disclosed in the notes to accounts if the inflow of economic benefits is probable.