IAS 37 Provisions, Contingent

Liabilities and Contingent Assets

Scope

• Applies to accounting for provisions, contingent liabilities and contingent assets except those:

– Resulting from executory contracts, unless they are onerous; or

– Covered by another standard

Say you sign a contract with W.Consulting to do quarterly IFRS updates from 2014 to 2019 at a cost for $1 million per annum on 31December 2014, what provision would you raise at 31

December 2015, 2016, and every year thereafter?

• So what’s an executory contract?

Key Definitions

• Liabilities– 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

• Provisions

– Liabilities of uncertain timing or amount

Key Definitions (cont’d)

• Accruals

– Are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier

– Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.

So, is Leave Pay a Provision or an Accrual?

Key Definitions (cont’d)

• Contingent liabilities

– Possible obligations arising from a past event to be confirmed by future events not wholly within the control of the entity, or

– Present obligations arising from a past event of which the outflow of economic benefits is not probable, or that cannot be measured reliably

Provisions- Recognition

• All 3 criteria must be met

– Must be a present obligation as a result of a past event

– Outflow of economic benefits must be probable

– Reliable estimate of outflow can be made

Recognition criteria -Legal or constructive

• Legal

– Contract

– Law / legislation

• Constructive

– Established pattern of past practice

– Published policies

– Create valid expectation

Recognition- Past Event

• No realistic alternative but to settle the obligation

• Not dependent on future actions of the entity

– Actions to reduce extent of obligation limit measurement not recognition

• Always involves a third party

– Even if that third party cannot be specifically identified

– Cannot arise from a purely internal decision

Recognition- Probable Outflow

• Probable means “more likely than not” or in geek speak: > 50% chance of occurring!

• For obligations like warranty provisions, this probability criteria is considered for the class of obligations as a whole

Recognition- Reliable Estimate

• Don’t be shy, estimate!

– Estimates are a necessary part of the preparation of AFS and do not undermine their reliability

• In most cases an entity will be able to determine a range of possible outcomes

• In extremely rare circumstances where it is not possible to determine a reliable estimate no provision is recognised (but exists) and a contingent liability is disclosed

• When do you recognise a contingent liability?

Next Year...maybe!

Recognition criteria cheat sheet–asset, liability or contingency?

Liabilities Outflow of economic benefits

Probable Possible Remote

Reliable estimate Liability

RecognisedContingent liabilityDisclose

Contingent liability

Do nothing

No reliable estimate

Contingent liability

Disclose

Contingent liability

Disclose

Contingent liability

Do nothing

Recognition criteria cheat sheet–asset, liability or contingency?

Assets Inflow of economic benefits

Virtually certain

Probable Possible Remote

Asset as per definition

Contingent asset

Disclose

Contingent asset

Do nothing

Contingent asset

Do nothing

Recognition criteria –judgement

Possible guidelines:

• Virtually certain: > 90 %

• Probable (more likely than not): > 50 %*

• Possible: < 50 %

• Remote: < 10 %

* In the standard

Provisions- Measurement

• Provisions are measured using the bestestimate of the expenditure required tosettle the obligation

• Best estimate is for a single event is themost likely outcome

• Best estimate for a large population of items(like a warranty provision) is determined byweighting the possible outcomes (financialimpact) by their associated probabilities-“expected value”

Provisions- Measurement

• Provisions are to be measured at presentvalue; where the impact of discounting ismaterial provisions should be discounted atthe appropriate pre-tax discount rate

• Discount rates should reflect the time valueof money and the risk associated with theliability being measured

IAS 37 – Reimbursements

• Recognise reimbursement only when virtually certain

• Reimbursement asset not offset against provision recognised for obligation

• Offset permitted in profit or loss

Prudence?

• Do not provide for...

– Future operating losses (rainy days)

– Maintenance / refurbishment of own assets

– General restructuring projects

– General business risks

Onerous contracts

• Contract in which unavoidable costs of meeting the obligation exceed the economic benefits expected to be received

• Measurement at the lower of:

– The fulfilment cost; or

– Any compensation or penalties arising from failure to fulfil it

• Consider additional impairment of assets dedicated to the onerous contract

Disclosure

• By category

– Brief description, timing, uncertainties of provisions

– Detailed roll-forward of provisions

– Expected and recognised reimbursements relating to provisions

– Brief description and financial effect of anycontingent assets and liabilities

Disclosure – an exception

• Disclosure not required in the rare circumstances when disclosure would seriously prejudice the position of the entity in a dispute with another party

• Disclose the general nature of the dispute and the fact that, and reason why, the information has not been disclosed

IFRIC 21 Levies

Background

• Issued in May 2013.

• Governments often impose levies on entities for various purposes.

• IFRIC received request for guidance on how to account for levies paid by entities.

Time to think…

Time to think…

What’s the difference between a levy and a tax?

LEVY? TAX?

IAS 12

Income taxes include all domestic and foreign taxes which are based on taxable profits.

IFRIC 21

A levy is an outflow of resources embodying economic benefits that is imposed by governments on entities in accordance with legislation (ie laws/regulations), other than:

• those outflows of resources that are within the scope of other Standards (such as income taxes that are within the scope of IAS 12 Income Taxes); and

• fines or other penalties that are imposed for breaches of the legislation.

Scope

IFRIC 21 addresses:

• the accounting for a liability to pay a levy if that liability is within the scope of IAS 37; and

• the accounting for a liability to pay a levy whose timing and amount is certain.

Scope

IFRIC 21 does not apply to:

• costs that arise from recognising a liability to pay a levy;

• outflows of resources within the scope of other Standards;

• payments for the acquisition of an asset, or for the rendering of services under a contractual agreement with a government;

• liabilities that arise from emissions trading schemes

IFRIC 21 Issues

What is the obligating event that gives rise to the

recognition of a liability to pay a levy?

Does economic compulsion to continue to operate in a

future period create a constructive obligation to pay a levy that will be triggered by operating in that future

period?

Does the going concern assumption imply that an

entity has a present obligation to pay a levy that

will be triggered by operating in a future period?

Does the recognition of a liability to pay a levy arise at a point in time or does it, in some circumstances, arise progressively over time?

What is the obligating event that gives rise to the

recognition of a liability to pay a levy that is triggered if

a minimum threshold is reached?

Are the principles for recognising in the annual

financial statements and in the interim financial report a

liability to pay a levy the same?

Issue 1: What is the obligating event?

• Consensus:

– Obligating event is the activity that triggers the payment of the levy, as identified by the legislation.

Time to think…

An entity operates in an industry that requires a levy to be paid when revenue is generated in 2014. The calculation of that levy is based on the revenue that was generated in 2013.

What is the obligating event:

a) The generation of revenue in 2014?

or

b) The generation of revenue in 2013?

Solution

The obligating event for the levy is the generation of revenue in the current period. The generation of revenue in the previous period is necessary, but not sufficient, to create a present obligation.

Issue 2: Does economic compulsion to operate create a constructive obligation?

• Consensus:

– An entity does not have a constructive obligation to pay a levy that will be triggered by operating in a future period as a result of the entity being economically compelled to continue to operate in that future period.

Time to think…

Beep Bank has a year end of 31 December. In accordance with legislation, a levy is triggered in full only if an entity operates as a bank at the end of the annual reporting period.

Questions:

(a) When should a liability be recognised?

(b) Would your conclusion in (a) change if the amount of the levy depends on the length of time of the reporting period?

Solution

• The liability is recognised on 31 December because the obligating event, as identified by the legislation, is Beep Bank operating as a bank at the end of its reporting period. Before that point, Beep Bank has no present obligation to pay a levy, even if it is economically compelled to continue to operate as a bank up to the year end and beyond.

• The conclusion would not change even if the amount of the liability is based on the length of the reporting period, because the obligating event is the entity operating as a bank at the end of its annual reporting period

Issue 3: Does the going concern assumption imply a present obligation that will be triggered by operating in future periods?

• Consensus:

– The preparation of financial statements under the going concern assumption does not imply that an entity has a present obligation to pay a levy that will be triggered by operating in a future period.

Issue 4: Does the recognition of a liability to pay a levy arise at a point in time or progressively over time?

• Consensus:

– The liability to pay a levy is recognised progressively if the obligating event occurs over a period of time.

Time to think…

• Savvy (Pty) Ltd has an annual reporting period that ends on 31 December. In accordance with legislation, a levy is triggered progressively as Savvy generates revenue during a reporting period. The amount of the levy is calculated by reference to revenue generated by the entity in each reporting period.

When should Savvy recognise the liability?

Solution

• The liability is recognised progressively during the period as Savvy generates revenue, because the obligating event, as identified by the legislation, is the generation of revenue during the period.

• At any point in the period, Savvy has a present obligation to pay a levy on revenue generated to date.

• Savvy has no present obligation to pay a levy that will arise from generating revenue in the future.

Issue 5: What is the obligating event that gives rise to the recognition of a liability to pay a levy that is triggered if a minimum threshold is reached?

• Consensus:

– If an obligation to pay a levy is triggered when a minimum threshold is reached, the accounting for the liability that arises from that obligation shall be consistent with the principles established in IFRIC 21.

Time to think…

Last Local Bank is required by legislation to pay a levy based on revenues as follows:

LLB’s revenue reaches the revenue threshold of R50 million on 10 July, and its year end is 31 December.

Revenue Percentage

0 – R50m 0%

R50m < 2%

Solution

– The liability is recognised between 10 July and 31 December as LLB generates revenue above the threshold.

– The obligating event, as identified by the legislation, is the activity undertaken after the threshold is reached (ie the generation of revenue after the threshold is reached).

– The amount of the liability is based on the revenue generated to date that exceeds the threshold of R50m revenue.

Issue 6: Are the principles for recognising in the annual financial statements and in the interim financial report a liability to pay a levy the same?

• Consensus:

– An entity applies the same recognition principles in the interim financial report that it applies in the AFS

– In the interim financial report, a liability to pay a levy:

• cannot be recognised if there is no present obligation to pay the levy at the end of the interim reporting period; and

• must be recognised if a present obligation to pay the levy exists at the end of the interim reporting period

Prepayments

• Recognise an asset if a levy has been prepaid but the entity does not yet have a present obligation to pay that levy.

Effective Date & Transition

• Interpretation effective for periods beginning on or after 1 January 2014.

• Early adoption allowed, with disclosure of the fact.

• Application is retrospective in accordance with IAS 8.