IAS 37 OUTLINES the accounting for provisions (liabilities of uncertain timing or amount), together with contingent assets (possible assets) and contingent liabilities (possible obligations and present obligations that are not probable or not reliably measurable).
Table of Contents
IAS 37 – Provisions
A liability of UNCERTAIN timing or amount.
Provisions are RECOGNIZED when all of the following conditions are met:
- The entity has a present obligation (legal or constructive) as a result of a past event;
- It is probable that the outflow of economic benefits will be required to settle the obligation; AND
- A reliable estimate can be made.
Provisions are MEASURED at the best estimate of the expenditure required to settle the present obligation at the reporting date.
[‘Best estimate’ is the amount that an entity would rationally pay to settle the obligation or to transfer it to a third party.]
|(i) Expected Value Method – Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities.|
|(ii) Most Likely Outcome – Where the provision involves a single obligation, the individual most likely outcome is the best estimate of the liability.|
2. Accounting for Provision As Per IAS 37
IAS 37 specifies that provision is RECOGNIZED in profit or loss (P&L).
Also, provision is recognized in the cost of another asset e.g, provision for removing the asset and restoring the site after its use.
SPLIT the provision in the current and non-current liabilities for presentation purposes in the statement of financial position.
2.2 Unwinding of Discount
When a provision has long-term nature (beyond 12 months), the amount of provision is the PRESENT VALUE of the expenditures expected to be required to settle the obligation.
In each reporting period, INTEREST on the opening balance of the provision is recognized in profit or loss (P&L) and it also increases the amount of provision.
Reimbursements from third parties for some or all expenditures required to settle a provision are recognized only when it is virtually certain that the reimbursements will be received.
It is treated as a SEPARATE ASSET, which cannot exceed the amount of provision.
2.4 Reversal of Provision
Provision is UTILIZED when expenditure associated with the settlement of the obligation is incurred.
If it is no longer probable that an outflow of Economic Benefits will be required to settle the obligation, the provision is REVERSED.
3. Future Operating Losses
Provision for future operating losses is NOT RECOGNIZED because there is no past event. The future operating losses can be AVOIDED by some future actions e.g, by selling a business.
However, assets should be tested for ‘Impairment’ under IAS 36.
It is a plan of Management to change the scope of business or a manner of conducting a business.
Restructuring provisions are RECOGNIZED when an entity has:
- A detailed formal plan for the restructuring identifying business or part of business concerned, principal locations affected, approximate number of employees to be compensated for termination of their services and expenditures that will be undertaken; AND
- 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 before the end of the reporting period.
Restructuring provisions only include the direct expenditures arising from the restructuring i.e. those that are BOTH necessarily entailed by the restructuring and NOT associated with the entity’s ongoing activities.
5. Onerous Contract
It is a contract in which unavoidable costs of fulfilling the contract EXCEED the economic benefits expected to be received from the contract.
For onerous contract, the provision is RECOGNIZED and MEASURED at lower of:
- The unavoidable cost of fulfilling the contract; OR
- The costs/penalties incurred in canceling the contract.
IAS 37 – Contingent Liabilities
A possible obligation that arises from past events, whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly in the control of the entity; OR
A present obligation that arises from past events that is NOT RECOGNIZED because:
- It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; OR
- The amount of the obligation cannot be measured with sufficient reliability.
[Contingent liabilities are NOT recognized.]
Contingent Liabilities are DISCLOSED in notes to the financial statement UNLESS the possibility of an outflow of resources embodying economic benefits is remote.
IAS 37 – Contingent Assets
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.
[Contingent assets are NOT recognized.]
However, when the realization of income is VIRTUALLY CERTAIN then the related asset is NOT a Contingent Asset and its recognition is appropriate.
IAS 37 was ISSUED in September 1998 and is operative for periods beginning on or after 1 July 1999.
Chartered Accountant (Institute of Chartered Accountants of Pakistan)
Bachelor of Accounting Honours (Asia e University, Malaysia)