International Accounting 8th. week
Recognition of provisions in accordance with IFRS According to Act on Accounting (SR) 431/2002 Col. of Laws, 26, article 5: Provisions are liabilities of uncertain timing or amount The same definition is stated by IAS 37.10 Liability is either present legal or constructive 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.
Legal vs. constructive obligation A legal obligation is an obligation that derives from: (a) a contract (through its explicit or implicit terms); (b) (c) legislation; or other operation of law (e. g. application of judicial precedents) A constructive obligation is an obligation that derives from an entity s actions: (a) by an established pattern of past practice, published policies or a sufficiently specific current 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 other parties that it will discharge those responsibilities.
Legal vs. constructive obligation Argent Co. is a mining company located near Scarborough village in Lantania (country). Even though there was a draft for a new legislation, which will ban any toxic agents used in production or domestic purposes, the act has not been approved yet; in addition, there is no legal responsibility of mining companies for any damage made on environment In 2009, there Argent Co. has issued press release about two major cases of leakage of such toxic agents Scarborough brings a case against Argent Co, however, the court dismissed a charge Quite recently (autumn 2010) CEO of the Argent company has promised that company will pay for any damage resulting from past, present or future leakage of such agents
Legal vs. constructive obligation Until autumn 2010, there was neither legal, nor constructive obligation of Argent Co. (and hence, no environmental liability) However, because of the public promise, constructive obligation has arisen Argent Co. need to estimate its expenditures required for restoration of environment due to past, present and future damages Because new liability will arise, Argent Co. shall account for expense as well Framework (70b): Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
However, there is a catch! In 2010, the estimated profit (before public promise has been made by the CEO) has been measured at 4 000 000 In 2011, it is assumed, that loss will account to 2 000 000 Provision for future environmental damages has been estimated in 2010 at 2 900 000 In 2010, only 400 000 has been required for settlement of any claims related to environmental damages
However, there is a catch! 5 000 000 4 000 000 3 000 000 4 000 000 3 300 000 2 000 000 1 000 000 0-1 000 000-2 900 000 1 100 000 1 300 000-2 000 000 2010 2011-2 000 000-3 000 000-4 000 000 Profit before provisions Impact of creation of provision on profit/loss Impact of reversal of provisions on profit/loss Profit after provisions
Recognition of provisions in accordance with IFRS There several IFRS s, which are focused on provisions In general, there is IAS 37 However, provisions are also dealt with in: IAS 16.16c (estimated expenditures for dismantling and disposal of an asset and restoration of surroundings is part of a cost of the non-current tangible asset) IAS 39.47c (accounting for financial guarantee) IAS 18.19 (recognition of revenues from sale of goods if only the reliable estimation of warranty cost could be made) IAS 11.22, 36 (if there is an expectation, that the construction contract will result in loss, the company should apply provisionlike approach i. e. immediate recognition of loss)
Provision for dismantling In accordance with IAS 16.16c estimated expenditures for dismantling and disposal of an item and restoration of surrounding are included in the (acquisition) cost of a non-current asset, if such obligation arise upon acquisition or during the use of such asset If such obligation arise from law or contract, it is a legal obligation) If it results from customs, habits or it is a result of an effort focused on improving relations with local community, it is a constructive obligation
Provision for dismantling For example, the purchase cost of a machinery has been 240 000, its transportation cost has been 5 000, expenditures related to training of employees are 15 000 and the total expenditures for dismantling and disposal are estimated at 2 400 Provided that there is a 2 % discount rate and the estimated useful life the machinery are 6 years, what will be carrying amount of machinery recognized upon initial recognition?
Provision for dismantling 240 000 + 5 000 + 2 174 (= 247 174 Year 5 4 3 2 1 EB Interest rate Interest 2 400 2% 47 2 353 2% 46 2 307 2% 45 2 262 2% 44 2 217 2% 43 BB 2 353 2 307 2 262 2 217 2 174
Valuation / Measurement According to the Act on Accounting in SR: 25: assumed liabilities are measured at cost, liabilities originating in company are measured at nominal value; liabilities acquired through the purchase of another business are measured at fair value However, 25, article 6 states: For the purpose of this Act... cost is the price, for which the asset has been acquired, and other expenditures, directly related to such acquisition...... nominal value... is the amount at which... the liability is stated... Provisions are liabilities of uncertain... amount What is the amount at which the liability of uncertain amount is stated?
Valuation / Measurement IAS 37.36 states, that provisions should be measured at best estimate of the expenditures which will be at the (current) reporting date required for settlement the obligation E. g., the employee is currently entitled for benefit worth 1 210, but the amount would be paid to him only after two years upon his written request; bank interest rate is 10 % p. a. (net of tax) How much the company need at the current reporting date, in order to either settle the obligation with employee, or transfer it to another party? 1 000 only. IF the amount would be deposited in bank, the interest for 1 st year would be 100 and for the 2 nd year 110 (10 in excess of the 1 st year is the result of compound interest. Consequently, the total amount after two years would be 1 210
Valuation / Measurement However, there might be several estimates (with different amounts) available Od, the estimate is stated as a range, rather than as a single number? For example, there is 20 % probability, that the warranty costs (for repair of your goods) will be 100 000, 50 % probability that it will be 200 000 and 30 % probability of 300 000 Or, estimated expenditures are within the range (100 000; 300 000 )
Valuation / Measurement For example, there is 20 % probability, that the warranty costs (for repair of your goods) will be 100 000, 50 % probability that it will be 200 000 and 30 % probability of 300 000 In accordance with IAS 37.39 the provision should be measured as follows: 20 % x 100 000 + 50 % x 200 000 + 30 % x 300 000; 210 000 Estimated expenditures are within the range (100 000; 300 000 ) In accordance with IAS 37.39, if all alternatives within the range has the same probability, midpoint of the range (200 000) is selected as a amount of related provison
Valuation / Measurement If the impact of time value of money is assessed to be material, provisions should be estimated from the discounted expenditures Materiality is defined in IAS 8 (in a narrative, rather than quantitative form) For discounting, discount rate reflecting time value of money and specific risk of the liability should be applied Specific risk should be included either in the amount of estimated expenditures or in discount rate; double counting the risk is prohibited
Reimbursements, creation, use and reversal of provisions Reimbusements are accounting for in accordance with IAS 37.53 Creation and reversal of provisions is made through profit or loss*, they are used in accordance with the purpose for which they have been created No provision shall be created for general risk, repairment of non-current assets or for the impairment of assets
Creation of provisions Creation of provisions is accounted for through profit or loss, with certain exceptions: a) provisions for restructuring b) provisions to be account for as a result of production
Provisions related to production Best estimate of expected expenditures have to be capitalized In continental Europe, you would recognized both expenses and income at the same amount Only impact on profit or loss will arise in the period when production will be consumed, impaired or sold
Provisions for restructuring They are covered in IAS 37 in great detail The reason is, that they are related to business combinations In accordance with IFRS 3, positive excess of consideration provided for the interest in certain company over its net assets as recognized as goodwill
Provisions for restructuring For example, for 800 you have purchased 100 % interest (share) in Sharkie Co., which has assets worth 1 000 and liabilities equal to 400 Net assets are 600, you have paid 800, the result is goodwill (asset) recognized at 200 However, if you (as a new owner) want to terminate contracts with employees of your subsidiary in exchange for flat benefit, provision for restructuring should be recognized However, increase of provision results in decrease of net assets by 100 and hence increase of goodwill by the same amount According to IAS 36, goodwill is tested for impairment rather than depreciated, However, if (after 2 yours) you change your plan, the provision should be reversed...... WHICH IS DONE THROUGH PROFIT OR LOSS
Provisions for restructuring In accordance with IAS 37.72, provision for restructuring should be recognized if entity: (a) has a detailed formal plan for the restructuring identifying at least: (i) the business or part of a business concerned; (ii) the principal locations affected; (iii) the location, function, and approximate number of employees who will be compensated for terminating their services; (iv) the expenditures that will be undertaken; and (v) when the plan will be implemented; and (b) has 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 by it.
Disclosure of related information IAS 37.84 and further Reconciliation of beginning and ending balances Information on use of judgments and estimates (e.g. discount rates, reimbursements) In accordance with IAS 37.92, certain sensitive information need not be disclosed... On the other hand if not remote, contingent assets and liabilities have to be disclosed
Contingent assets and contingent liabilities A contingent liability is: (a) a possible obligation... whose existence will be confirmed only by... uncertain future events not wholly within the control of the entity (there is a legal dispute) (b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation (e. g. the likelihood is lower than it is required under IAS 37.15) (ii) the amount of the obligation cannot be measured with sufficient reliability
Contingent assets and contingent liabilities A contingent asset is a possible asset... whose existence will be confirmed only by... uncertain future events not wholly within the control of the entity
Zamestnanecké požitky V princípe upravované: IAS 19 (všeobecný štandard) IFRS 2 (ak sú požitky viazané na akcie) IAS 26 (výsledky fondu zamestnaneckých požitkov)
Zamestnanecké požitky podľa IAS 19 Zamestnanecké požitky (ang. employee benefits): a) krátkodobé b) dlhodobé Požitky, nie pôžitky! Dlhodobé zamestnanecké požitky: a) pri predčasnom ukončení zamestnania b) po ukončení zamestnania c) ostatné dlhodobé zamestnanecké požitky
Rozlišovanie prev{dzkových a finančných n{kladov Používa sa metóda očakávaných jednotiek zásluhovosti (ang. Projected Unit Credit Method) Počet rokov za ktoré sa počítajú n{roky 5 N{roky za každý odpracovaný rok 400 N{roky spolu 2 000 Diskontn{ sadzba 3,0% 1 2 3 4 5 SPOLU Zamestnanecké požitky v poslednom roku 400 400 400 400 400 2 000 Odúročenie 1,126 1,093 1,061 1,030 1,000 x Zamestnanecké požitky bežného obdobia 355 366 377 388 400 1 487 1 2 3 4 5 SPOLU Zamestnanecké požitky na zač. obdobia (Z) 0 355 732 1 131 1 553 x Úroky 0,000 10,662 21,963 33,933 46,602 67 Zamestnanecké požitky bežného obdobia (N) 355 366 377 388 400 1 487