FAC PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS IAS 37

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Patrick Douglas
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1 FAC PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS IAS 37

2 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS STUDY OBJECTIVES: 1. PROVISIONS VS OTHER LIABILITIES 2. RECOGNITION OF A PROVISION 3. CONTINGENT LIABILITIES 4. CONTINGENT ASSETS 5. MEASUREMENT OF A PROVISON 6. REIMBURSEMENTS 7. ONEROUS CONTRACTS 8. RESTRUCTURING 9. DISCLOSURE 2

3 1. PROVISIONS VS OTHER LIABILITIES 1.1 Provision is a liability of uncertain timing an amount versus trade payables versus accruals 1.2 Provision for doubtful debts or inventory write-down are not liabilities 1.3 Provisions are reported separately from payables 1.4 Liability Provision Contingency recognised recognised not recognised (but disclosed) 3

4 2. RECOGNITION OF A PROVISION 2.1 Recognise when all 3 conditions met: there is a present legal or constructive obligation as a result of a past event probable that there will be an outflow of economic benefits a reliable estimate can be made of the amount 2.2 Existence of present obligation it is more likely than not otherwise disclose a contingent liability 2.3 A constructive obligation derives from an entity s actions eg. an oil company having a widely published environmental policy of cleaning up contamination it causes eg. retailer has a known refunds policy but no legal obligat. 4

5 2. RECOGNITION OF A PROVISION 2.4 Notion of past event past event must give rise to an obligating event whereby an entity has no realistic alternative to settling the obligation only recognise liabilities that exist at end of year the obligation must exist independently of an entity s future actions eg. obligation for penalties / clean-up costs by oil company eg. no obligation now if a factory intends to or needs to (by law) to fit smoke filters next year. 2.5 Provision not recognised for future operating losses 5

6 3. CONTINGENT LIABILITIES 3.1 Contingent liabilities are either: possible obligations ; or present obligations that do not meet the recognition criteria 3.2 A contingent liability is not recognised only exception is in a business combination IFRS A contingent liability is disclosed unless outflow of benefits are remote what happens if outflow of economic benefits become probable? 6

7 4. CONTINGENT ASSETS 4.1 A contingent asset is a possible asset eg lawsuit claim bad debt recoverables 4.2 A contingent asset is not recognised. logical as will clash with accounting theory income may never be realised unless realisation virtually certain then not a contingent asset 4.3 NB: if future inflow of economic benefits is probable disclose contingent asset (unlike a contingent liability) 7

8 5. MEASUREMENT OF A PROVISION 5.1 Amount for the provision must be the best estimate taking into account risks and uncertainties take account future events expected to occur (eg future changes in technology for restoring the environment) 5.2 Present value the provision where the time value is material 5.3 Do not take into account gains from expected disposal of assets (for eg in provision for the closure of a division) 5.4 Review provision each year and adjust / reverse if appropriate 8

9 6. REIMBURSEMENTS 6.1 Amount required to settle a liability may be reimbursed by: insurance company or suppliers warranty 6.2 Recognise reimbursement only when it is virtually certain that reimbursement will be received 6.3 Reimbursement must be treated as a separate asset -no set-off expense relating to provision in stat. of comprehensive income may be presented net of reimbursement 9

10 7. ONEROUS CONTRACTS 7.1 An onerous contract is one where: The unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received 7.2 Routine purchase orders Is an executory contract When are they also onerous contracts? 7.3 Unavoidable cost reflect the least net cost of exiting contract Which is the lower of the cost of fulfilling it and any penalties 10

11 8. PROVISION FOR RESTRUCTURING 8.1 Restructuring specifically defined as a programme... may be sale or termination of a line of business closure of business locations or relocation of business changes in management structure, etc 8.2 NB. Link with IFRS 5 - a discontinued operation is restructuring 8.3 Use general recognition criteria for a provision for restructuring 8.4 A constructive obligation to restructure arises when: there is a detailed formal plan identifying entity has raised a valid expectation in those affected... 11

International Accounting Standard 37 Provisions, Contingent Liabilities and Contingent Assets

IAS 37 International Accounting Standard 37 Provisions, Contingent Liabilities and Contingent Assets Objective The objective of this Standard is to ensure that appropriate recognition criteria and measurement