Ind AS-37 Provisions, Contingent Liabilities & Contingent Assets

Transcription

1 Ind AS-37 Provisions, Contingent Liabilities & Contingent Assets Chamber of Tax Consultants 10 October, 2017 ZFB & ASSOCIATES, Chartered Accountants 1

2 Contents Objective and Scope Meanings Recognition of Provisions Measurement of Provisions Restructuring Accounting for Levies Transition Issues Disclosures Case Studies ZFB & ASSOCIATES, Chartered Accountants 2

3 Objective and Scope The main objective of the Standard is to ensure that appropriate recognition criteria and measurement basis are applied to provisions, contingent liabilities and contingent assets coupled with disclosure of sufficient information to enable an understanding of their nature, timing and amount. It applies to accounting for all provisions, contingent liabilities and contingent assets, except as under: a) Those resulting from executory contracts (those where neither party has performed any of its obligations or both parties have equally performed their obligations to an equal extent) other than onerous contracts; and b) Those which are covered by other Standards - Income Taxes, Employee Benefits, Leases other than Operating Leases which are Onerous, Insurance Contracts, Construction Contracts, Financial Instruments (whether carried at fair value or not) and Guarantee contracts and Contingent Consideration of an Acquirer in a Business Combination ZFB & ASSOCIATES, Chartered Accountants 3

4 Meanings Provision a liability of uncertain timing or amount. The parties to whom the paymentsaretobemadearegenerallynotknownintheinitialstages. Examples of Provisions: a. Provision for product warranty b. Provision for customer reward points c. Provision for site restoration d. Legal obligations / disputes Liability a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. The parties to whom the amounts are payable are identified. Examples of Liabilities: a. Accrued Interest payable on loans b. Amounts payable for goods received but invoice yet to be received c. Amounts payable for utilities like electricity and telephone d. Financial guarantees given by the parent to the bank for loans availed by group companies ZFB & ASSOCIATES, Chartered Accountants 4

5 Meanings Contingent Liability exhibits the following characteristics: a) A possible obligation that arises from past events whose existence would be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or b) A present obligation arising from past events which is not recognised due to non-probability of outflow of resources or lack of sufficient reliability to measure the amount of the obligation. Contingent Asset is a probable asset that arises from past events whose existence would be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity.thesearenottoberecognised. ZFB & ASSOCIATES, Chartered Accountants 5

6 Recognition of Provisions A provision is recognised if the following conditions are satisfied: a) Entity has a present obligation (legal or constructive) as a result of a past event; b) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and c) A reliable estimate can be made of the amount of the obligation. Present Obligation: a) In most cases, it would be clear based on a past event b) In rare cases where the entity is involved in a legal suit, it would be necessary to determine the present obligation taking into account all available evidence, including expert opinions. Para 9(a) of IndAS-10 specifically provides that the settlement of a court case after the reporting period is an adjusting event which provides evidence of the existence of a present obligation which may lead to a contingent liability being recognised ZFB & ASSOCIATES, as a Chartered provision Accountantsor re measurement of the6 amount of the provisions. To evaluate for decisions at lower levels

7 Recognition of Provisions Past Event: a) A past event that leads to a present obligation is referred to as an obligating event, which implies that the entity has no realistic alternative other than to settle the obligation created by the event. b) It is not necessary that the identity of the party to whom the obligation is owed is known from the beginning. In many cases the obligation could be to the society at large e.g. clean up costs for environmental damage, decommissioning costs for a power plant etc. An obligating event may arise due to the following: a) Legal Obligation or b) Constructive Obligation ZFB & ASSOCIATES, Chartered Accountants 7

8 Recognition of Provisions A legal obligation, arises on account of either: a) A contract, whether explicit or implied; b) Legislation; or c) Other Operation of Law Example:- Anelectricity distribution company is required to lay cables and is also required by state laws to restore the soil base whenever they have laid the cables at the end of the contract period provision to be made to theextentthecableshavebeenlaiddownsinceitisalegalobligation ZFB & ASSOCIATES, Chartered Accountants 8

9 Recognition of Provisions A constructive obligation is an obligation which derives from an entity s actions where: a) By an established pattern of past practice, published policies or a sufficiently specific current written statement, the entity has indicated to other parties that it will accept certain responsibilities; and b) As a result the entity has created a valid expectation on the part of those parties that it would discharge those responsibilities. Amanagement orboarddecisionat theendofthereporting perioddoesnot give rise to a constructive obligation unless the decision is communicated before the end of the reporting period to those affected in a sufficiently specific manner so as to raise a valid expectation of its fulfilment by the entity. (e.g. negotiations commenced by the HR department for wage revisions but pending the final decision of the Board which is expected after the Balance Sheet date dos not give rise to a constructive obligation) ZFB & ASSOCIATES, Chartered Accountants 9

10 Measurement of Provisions The provision shall be measured at the best estimate of the expenditure required to settle the obligation. Principles for determining the best estimates: a) Rational basis of payment: - management judgement or experts opinion. b) Provision for large population of events: - measured at the probability weighted expected value. Examples include customer refunds, warranty provisions. c) Single Estimate:- measured at the most likely value. Examples include law suits, environmental clean up. d) Risks and Uncertainties: - These may need to be factored based on assigning probability to a range to outcomes. ZFB & ASSOCIATES, Chartered Accountants 10

11 Measurement of Provisions d) Present Value:- If the effect of time value of money is material, provision (Cash flows) should be measured at its present value. For this purpose, the discount rate would be the pre tax rate that reflects the current market assessment of the time value of money and risks specific to the liability and without adjusting it for cash flow. Real v/s nominal rate (Current prices excluding general inflation v/s future prices including effect of inflation) e) Gain on Disposal of Asset:- Gains on expected disposal of assets are not taken into account in measuring the provision even if the expected disposal is closely linked to the event giving rise to the provision. f) Reimbursement Asset:- If all or a portion of the expenditure required to settle a provision is to be reimbursed by a third party, such reimbursement should be recognised as an asset only when it is virtually certain that the same will be received when the entity settles the obligation. ZFB & ASSOCIATES, Chartered Accountants 11

12 Measurement of Provisions d) Future Operating Losses:- No provisions should be recognised for future operating losses. (e.g. Company being required to install safety equipment from next year for the products which it is currently manufacturing is in the nature of a future operating cost) e) Onerous Contracts:- Such contracts are those for which the unavoidable cost of meeting the obligations exceed the economic benefits expected to be received under it. Any such obligations should be recognised and measured as a provision in accordance with the requirements of the Standard ZFB & ASSOCIATES, Chartered Accountants 12

13 Restructuring Definition:- a programme that is planned and controlled by the Management, which materially changes either: a)the scope of business undertaken by the entity; b)the manner in which the business is undertaken by the entity. Common examples include: a)sale or termination of a line of business; b)closure of business locations in a country or region; c)relocation of business activities; d)changes in the management structure. ZFB & ASSOCIATES, Chartered Accountants 13

14 Restructuring Components of Restructuring Costs:- only the direct expenditure arising from the restructuring which are both: a)necessarily entailed by the restructuring; and b)not associated with the ongoing activities of the entity. The following are not ordinarily considered as restructuring related provisions: a) Retraining or relocating staff b) Marketing costs c) Investments in new systems and distribution networks d) Expenditure for future conduct of the business. e) Identifiable future operating losses unless they relate to an onerous contract. ZFB & ASSOCIATES, Chartered Accountants 14

15 Restructuring General considerations for recognition of provisions same as discussed earlier Other special conditions which are required to be fulfilled for recognition of provision for restructuring costs and related matters: a) Timing when Constructive Obligations arises: - It arises only when the an entity has: I. A detailed formal plan of restructuring covering amongst other matters, the business or part thereof involved, locations, functions and employees affected and likely to be compensated, the expenditure to be undertaken, the schedule of implementation; and II. Raised a valid expectation in those affected that it would undertake the restructuring by starting the implementation of the plan coupled with an implementation schedule or announcing its main features to those affected. A long delay in implementation is unlikely to give rise to a valid expectation. ZFB & ASSOCIATES, Chartered Accountants 15

16 Restructuring b) Impact of Board Decisions:- The impact thereof needs to be evaluated as under: I. A Board decision by itself is not sufficient to trigger a constructive obligation and it should be supported by an implementation schedule or a public announcement as per (a) above. II. However, in cases where negotiations with employees for termination payments or with purchasers for sale of operations have been concluded, subject to only the Board approval, the constructive obligation would arise once the said approval has been obtained and communicated to the other parties, subject to it being supported by an implementation schedule or a public announcement as per (a) above. III. Incase the Board decision is taken before the end of thereporting period but the implementation starts or the public announcement is made after the reporting period but before the financial statements are approved, itwould be a non-adjusting event as per IndAS-10 and merely a disclosure thereof would suffice. c) Sale of Assets:- No obligation arises for the sale of an operation until the entity is committed to the sale i.e. there is a binding sale obligation. However, when the sale of an operation is envisaged as a part of restructuring, the assets thereof need to be reviewed for impairment in accordance with IndAS-36. ZFB & ASSOCIATES, Chartered Accountants 16

17 Accounting for Levies A levy is an outflow of resources embodying economic benefits that is imposed by the Government in accordance with legislation, other than: a) Those which are dealt with by other Standards (e.g. Income Tax); and b) Fines and penalties that are imposed for breach of legislation. The obligating event that gives rise to a liability to pay a levy is the activity that triggers (at a point of time, on a specified date or when a transaction occurs) the payment thereof as per the legislation e.g. the revenue earned. The same recognition principles as applicable to provisions shall be applied. The preparation of financial statements on a going concern basis does not imply that an entity has a present obligation to pay a levy that would be triggered by operating in a future period. The liability to pay levy is recognised progressively if the obligating event occurs over a period of time. An asset should recognised if the levy has been prepaid for which there is no present obligation ZFB & ASSOCIATES, Chartered Accountants 17

18 Transition Issues and Challenges Ind AS-101 puts Restrictions on retrospective application of estimates based on hindsight unless there is objective evidence of errors. Estimates that were not necessary under previous GAAP can be considered for making provisions these conditions that arose after the transition date should not reflect No exemptions to retrospective application of the Standard a. time value measurement b. derecognition of reimbursement assets which are not virtually certain c. settlement of legal cases after reporting period triggering a present obligation d. recognition of constructive obligations not previously recognised (Sales returns, reward points etc.) ZFB & ASSOCIATES, Chartered Accountants 18

19 Disclosures Nature of Disclosure Description / Requirements Break up of provisions Opening Balance + Additional provision + Increase due to unwinding of discount - Amount utilised against the liability / loss - -Reversal of provision not required - = Carrying amount at the end of the period NB: The above disclosures to be given for each class of provisions Description a) Description of the obligation, timing and amount of outflow embodying economic benefits b) Associated uncertainties and how these are reflected in measuring the provision c) Reimbursements, if any Disclosure of Contingent Liabilities a) Estimate of the financial effect; b) Associated uncertainties c) Reimbursements, if any ZFB & ASSOCIATES, Chartered Accountants 19

20 Case Studies Case Study No. 1 Discuss whether CSR obligations under the Companies Act, 2013 could trigger a constructive obligation? ZFB & ASSOCIATES, Chartered Accountants 20

21 Case Studies Solution: The Companies Act, 2013 currently does not prescribe any specific penal provisions if a Company does not spend on the prescribed CSR activities and the Board of Directors are only required to explain the reasons for such noncompliance in their report. Hence it can be argued that there is technically no legal obligation to incur such expenditure. However, in view of the specific provisions, if not a legal obligation, it could be argued that the Companies specifying the prescribed criteria atleast have a constructive obligation to incur the CSR expenditure. The existing AS-29 does not specifically recognise the concept of constructive obligations and only requires provisions to be created on matters arising out of normal business practices, customs and a desire to maintain good business relations or to act in an equitable manner. Further, there are 2 EAC opinions which confirm that constructive provisions need not be provided for. Hence under the current Indian GAAP, there is no provision created towards unspent CSR amount unless there is a contractual obligation and commitment to incur the same like any other expenditure. ZFB & ASSOCIATES, Chartered Accountants 21

22 Case Studies Under Ind-AS, whilst the legal obligation still does not persist, it would be advisable to seek a legal opinion on whether there is a constructive obligations depending upon the facts and circumstances of each case. The requirement of a constructive obligation could arise due to the following requirements under the Companies Act, 2013: Formulating and recommending a CSR policy which would indicate the activities to be undertaken by the Company; Recommending the amount of expenditure to be incurred by the Company on the activities referred to in the CSR policy; Monitoring the CSR policy from time to time; and Disclosures to be made in the Board Report and on the web site. The above matters, especially the disclosures in the Board Report and the web site could trigger a constructive obligation in line with the principles laid down in the Ind-ASsince through a sufficiently specific current written statement, the entity has indicated to other parties or to the general public that it will accept certain responsibilities and asa result it has created a valid expectation on the part of those parties that it would discharge those responsibilities. Accordingly, the Company could be required to create a provision for the short spend. A clarification by the MCA or ICAI in this regard is welcome. ZFB & ASSOCIATES, Chartered Accountants 22

23 Case Studies Case Study No. 2 A Company operates several petrol pumps. The Management has approved a reorganisation plan which involves closure of 8 petrol pumps out of a total of 20 which yield a revenue of approximately 60%, which plan has been publicly announced without identifying the specific pumps due to confidentiality issues. a) Does a restructuring event get triggered? b) Advise the company of the likely costs which would fall within the definition of restructuring costs? ZFB & ASSOCIATES, Chartered Accountants 23

24 Case Studies Solution: As per the Standard, a constructive obligation arises only when the entity has a detailed plan for restructuring and announces it to those affected by it. In the above case, the management has not identified / disclosed the specific pumps which are to be closed and hence a provision for restructuring costs is not triggered. ZFB & ASSOCIATES, Chartered Accountants 24

25 Case Studies Case Study No. 3 A chemical company causes contamination of land. Currently there is no law which requires cleaning of the same. However, due to pressure from various public interest groups, a draft law requiring clean- up of such lands and providing rehabilitation compensation with retrospective effect has been introduced in parliament as on 31 st March, 2016 and the same was passed by parliament on 10 th May, 2016 but awaiting presidential assent on the date of approval of the financial statements which is 15 th May, The law proposed that the clean-up and rehabilitation would need to be completed within two years. The time value of money is estimated at 10% for similar liabilities. In view of the likely hood of enactment of the aforesaid law, the company has initiated inquiries with various experts on the likely clean-up costs, which are summarised in the next slide Based on the above facts evaluate whether the Company is required to make a provision as on 31 st March, 2016 and if so, the amount which needs to be provided. ZFB & ASSOCIATES, Chartered Accountants 25

26 Case Studies Outcome Amount Rs. Probability Most Optimistic 100 lakhs 30% Most Likely 85 lakhs 60% ZFB & ASSOCIATES, Chartered Accountants 26

27 Case Studies Solution: The fact of the draft law being passed by parliament after the year end with retrospective effect will trigger an obligating event leading to a present obligation to clean up the lands and pay rehabilitation competition. Further considering that the law was passed on the basis of public opinion and since the obtaining of the presidential assent is only a formality, it can be concluded that the enactment of the legislation is virtually certain thereby triggering the obligating event. Accordingly the provision would need to be measured at the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. In the given case, since single obligation is being measured, the individual most likely outcome with the highest probability based on the expert opinion would be the best estimate of the liability. Further, since the same is expected to be settled over more than one period, the discounting of the time value of money would also need to be factored in, which isreflected as under: Provision for Site Restoration = Rs. 85 lakhs = Rs lakhs (1+10%)2 ZFB & ASSOCIATES, Chartered Accountants 27

28 Questions???? ZFB & ASSOCIATES, Chartered Accountants 28