IAS 37

Provisions, contingent liabilities and

contingent assets
IAS 37 - content
• Provisions

• Contingent liabilities and contingent assets

2
IAS 37 - content
Provisions
• Definition
• Recognition
• Obligation
• Accounting Treatment
• Measurement
• Change in a provision
• Provision resulting in an asset
• Specific applications
▫ Future operating losses
▫ Onerous contracts
▫ Restructuring
• Disclosures
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IAS 37 - content
Contingent Liabilities
• Definition
• Accounting treatment
• Disclosures

Contingent Assets
• Definition
• Accounting treatment
• Disclosures

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Provisions - definition

Provision – a liability of uncertain timing or amount.

Liability – 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.

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Recognition

Per IAS 37 a provision should be recognised when:

• An entity has a present obligation (legal or constructive) arising from
a past event

• It is probable that an outflow of resources embodying economic

benefits will be required to settle the obligation

• A reliable estimate can be made of the amount of the obligation

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 Obligation

LEGAL CONSTRUCTIVE

An obligation that derives from: An obligation that derives from an

• A contract entity’s actions where:
• Legislation • By an established pattern of past
practice, actions or policies, the
• Other operation of law
entity has created valid
expectations towards third
parties.

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Accounting Treatment

By recording a provision:

• An expense is recorded in the Statement of Profilt or Loss (P/L)

• A liability is recorded on the Statement of Financial Position (SFP)

Dr Expenses ( P/L) xx
Cr Provision (SFP) xx

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Measurement of Provisions

The amount provided should be the “best estimate” of the expenditure

required to settle the present obligation at the end of the reporting
period.

SINGLE LARGE
OBLIGATION POPULATION

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Single Obligation

Example
The expenditure of a single obligation is estimated at €20,000 and
there is a 60% chance of the expenditure being incurred.
The process of estimating the amount involves two steps:
1. Is it probable there will be an outflow of economic resources?
2. Can a reliable estimate be made?

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Large Population

Where there is a large population of items, the obligation is estimated

by weighting all possible outcomes by their associated probabilities to
arrive at the expected value.

Example: Warranties

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Example

ABC plc sells goods which carry a one-year repair warranty. If minor
repairs were to be required for all goods sold in 2014, the cost would be
£100,000. If major repairs were to be needed for all goods sold in 2010,
the cost would be €500,000.

ABC plc estimates that 80% of goods sold in 2014 will have no defects,
15% will have minor defects and 5% will have major defects.

Requirement
Calculate the provision for repairs required at 31 December 2014

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Solution

Provision = (80% x o) + (15% x 100000) + (5% x 500000)

= €40,000

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Discounting

• Where the effect of the time value of money is material, the amount of
the provision should be discounted
• i.e. it should be recorded at the present value of the expenditure
required to settle the obligation.

• This is likely to be an issue when there is a significant period of time

between the end of the reporting period and settlement of the
obligation.

• The discount rate used should be the pre-tax rate that reflects current
market assessments of the time value of money and the risks specific
to the liability.

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Discounting

• Over the period between the recognition of a provision and its

ultimate settlement, the provision should be increased each year by
the discount rate.

• The increase should be recognised as a finance cost in profit or loss,

not as a further expense under the line item where the original
provision was charged.

• This is known as “unwinding of the discount”.

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Example

ABC Plc has a present obligation at 31 December 2014, which it expects

to settle in three years' time for €100,000. The rate which reflects the
time value of money and the risks specific to the liability is 10%.

Requirement
1. At what amount should the provision be measured at 31 December
2014?
2. How much should be recognised as a finance charge in each of the
three years ending 31 December 2015, 2016 and 2017?

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Solution

1. The provision should be measured at its present value at 31

December 2014:

€100,000/(1.1)³ = 75,131

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Solution
2. The finance charge in each of the three years is calculated as:

Balance Finance cost Balance

b/f @ 10% c/f 31 Dec
€ € €
2015 75,131 7,513 82,644
2016 82,644 8,264 90,908
2017 90,908 9,092 100,000

To record the finance cost, the entry at each year end is:
Dr Finance cost (P/L)
Cr Provisions (SFP)
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Future events

• Future events such as changes in technologies, efficiency improvements

and changes in legislation may have a significant impact on the
measurement of provisions.

• These should be taken into account where there is sufficient objective

evidence that they will occur.

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Expected disposals of assets

• Gains from the expected disposal of assets should not be taken into
account in measuring a provision even if the expected disposal is closely
linked to the event giving rise to the provision.

• Instead, such gains are accounted for under the relevant IFRS

IAS 16 Property, Plant and Equipment

IFRS 5 Non-current Assets Held for Sale and Discontinued Operations

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Reimbursements

• In some cases, an insurance company or a supplier under a warranty

may reimburse all or part of a company’s expenditure to settle a
provision.

• If so the reimbursement should be recognised only when it is virtually

certain that reimbursement will be received if the entity settles the
obligation.

• IAS 37 requires that the reimbursement should be:

1. Treated as an asset in the SFP separate from the provision; and
2. Recognised in the SFP at an amount not exceeding the amount of
the provision

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Example

• A customer sues Restaurant X for food poisoning, €50,000.

• Restaurant X makes a counter claim against their suppliers for

€70,000.

• Per the legal advisers, both claims are certain to succeed.

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Solution

Statement of Financial Position

€
Current Assets
Receivables 50,000

Current Liabilities
Provisions 50,000

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Changes in Provisions

• Provisions are inherently uncertain

• IAS 37 requires that they should be reviewed at the end of each

reporting period and adjusted to reflect the current best estimate

• If a transfer of economic benefit is no longer probable, the provision

should be reversed.

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Use of provisions

• IAS 37 specifies that a provision should be used only for expenditures

for which the provision was originally recognised.

• If a provision is no longer required for its originally intended purpose,

it should be reversed and not used to conceal the impact of other
unrelated expenditure.

• The reversal is a change of accounting estimate (IAS 8) and is

recognised in profit or loss in the year of reversal.

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Recognising an asset when recognising a
provision

• In some cases, an obligation may arise from a past event before an

entity has obtained economic benefits from the event concerned, but
the entity reasonably expects to obtain such future benefits.

• In this case the amount of the provision is also recognised as an asset,

to be written off over the period of the asset’s useful life.

• For example, under IAS 16 a provision for the initial estimates of

dismantling and removing an item of PPE and restoring the site on
which it is located is included in the cost of the item.

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Example

A company establishes a new quarry and has a legal obligation to

restore environmental damage once quarrying is completed. Before
rock can be extracted for sale, the overlying material (the overburden)
must be removed, causing environmental damage. The overburden
itself has no commercial value. The estimated cost of remedying the
damage caused by removal of the overburden is €60,000 (ignore
discounting).

Requirement
How would you record the provision for environmental damage
rectification arising out of removal of the overburden?

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Solution

Dr PPE (SFP) 60000

Cr Provisions (SFP) 60000

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Specific Applications per IAS 37

• Future operating losses

• Onerous contracts

• Restructuring

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Future operating losses

• Provisions should not be recognised for future operating losses

• They do not meet:

- the definition of a liability
(as they arise from future, not past events)

- the general recognition criteria per IAS 37

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Onerous contracts

Definition

An onerous contract is a contract in which the unavoidable costs of

meeting the obligations under the contract exceed the economic benefit
expected to be received under it.

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Onerous Contracts

Unavoidable costs

Lower of

Compensation/penalties
Costs of fulfilling the arising from failure to
contract fulfil the contract

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Onerous Contracts

Treatment

• At the year end, there is an obligation to meet the contract

• Therefore a provision must be recognised

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Example

A company rents a building under an operating lease, but vacates the

building shortly before the end of its reporting period, due to business
relocation. The lease on the vacated building has three years to run and
cannot be cancelled. The building cannot be sub-let.

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Solution

In this case, the conditions for making a provision are met as:

• A present obligation exists as a result of a past event (the signing of

the lease)

• An outflow of resources embodying economic benefit in settlement is

probable (rentals for the remainder of the lease term); and

• The amount can be measured reliably (the future rentals, discounted if

material).

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Restructuring

Definition

Restructuring is a programme that is planned and controlled by

management, and materially changes either:
• The scope of a business undertaken by an entity; or
• The manner in which that business is conducted.

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Restructuring

Examples

• Sale or termination of a line of business

• Closure of business locations or the relocation of business activities

• Changes in management structure

• Fundamental reorganisations that have a material effect on the nature

and focus of the entity’s operations.

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Restructuring

• The key accounting issue is whether, and if so, when, to recognise a

provision for a planned restructuring.

• IAS 37 treats a restructuring as creating a constructive obligation

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Restructuring

Only provide for restructuring costs when an entity

Has a detailed formal AND

Has raised valid
plan identifying at least:
expectation in those
affected that it will carry
•The business concerned
out the restructuring by
•The principal locations
starting implementation
•The employees affected
or announcing its main
•The expenditure
features
required
•The timing

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Restructuring

A management or board decision taken before the end of the reporting

period in itself does not give rise to a constructive obligation at the end
of the reporting period unless the entity has:
• Already begun implementation; or
• Made a public announcement of the main features sufficient to
establish a constructive obligation.

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Restructuring

A similar decision taken after, not before, the end of the reporting
period will normally require disclosure as a non-adjusting event after
the reporting period, under IAS 10

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Restructuring - Measurement of provision

A provision should include only the direct expenditures arising from the
restructuring, which are both:
• Necessarily entailed by the restructuring; and
• Not associated with ongoing activities.

This therefore excludes:

• Indirect costs (for example retraining or relocating staff in a
continuing operation)

• Provisions for future losses of the restructured operation ( unless they

relate to onerous contracts)

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Examples

In which of the following circumstances might a provision be

recognised? (The accounting date is 31 December)

1. On 15 December 2014 the board of an entity decided to close down a

division. Before 31 December 2014 the decision was not
communicated to any of those affected and no other steps were
taken to implement the decision.

2. As (1) above except that the board agreed a detailed closure plan on
20 December 2014 and details were given to customers and
employees.

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Examples

3. A company is obliged to incur clean up costs for environmental

damage (that has already been caused).

4. A company intends to carry out future expenditure to operate in a

particular way in the future.

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Disclosures

Key IAS 37 numerical disclosures for each class of provision are:

• Carrying amounts at the beginning and end of the period

• Movements during the period, including:

 Amounts provided
 Amounts used
 Unused amounts reversed
 Increases due to unwinding of a discount
 Effect of changes in the discount rate

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Disclosures

Key IAS 37 narrative disclosures for each class of provision are:

• A brief description of the nature of the obligation and expected timing

of any resulting outflows of economic benefits

• An indication of the uncertainties involved

• The amount of any expected reimbursement, stating the amount of

any asset that has been recognised for the expected reimbursement

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Note X: Provisions

Warranty Returns Total

provision provision

£ £ £
At 1 July 2008 70,000 37,000 88,000
Additions 35,000 20,000 57,000
Amounts used during year (63,000) (32,000) (91,000)
At 30 June 2009 42,000 25,000 54,000

The warranty provision relates to estimated claims on those products sold in the
year ended 30 June 2014 which come with a one year warranty. A weighted
average method is used to provide a best estimate. It is expected that the
expenditure will be incurred in the next year.

The returns provisions relates to an open returns policy offered on all goods.
Customers are given 28 days in which to return goods and obtain a full refund.
The provision at the year end is based on a percentage, using past experience, of
the number of sales made in June 2014.

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Contingent liabilities

Definition

A contingent liability is either:

• A possible obligation 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, or

• A present obligation that arises from past events but is not recognised
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.

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Accounting treatment

• Contingent liabilities should not be recognised in the financial

statements, but may require disclosure

• Because contingent liabilities are inherently uncertain, they should be

assessed continually to identify whether the criteria for recognising a
provision have been met.

• If this occurs, a provision should be recognised in the period in which

the criteria are met.

• This would represent a change of accounting estimate regarding the

likely outcome of an uncertain situation.

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Disclosures – Contingent Liabilities

Unless the possibility of any outflow in settlement is remote, the

following disclosures should be made for each class of contingent
liability at the end of the reporting period:

• A brief description of its nature; and

• Where practicable:
 An estimate of the financial effect (measured in the same way as a
provision)
 An indication of the uncertainties; and
 The possibility of any reimbursement

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Contingent assets

Definition
A contingent asset is a 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.

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Accounting treatment

• A contingent asset must not be recognised.

• Recognition only takes place when the realisation of the related

economic benefits is virtually certain ie at the point the asset is no
longer contingent (This is an application of the prudence concept).

• Contingent assets should be assessed continually to identify whether

the uncertainty has been removed.

• If events confirm the existence of an asset, it should be recognised

provided that it can be measured reliably.

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Disclosures – Contingent Assets

• Where an inflow of economic benefits is probable (more likely than

not), the contingent asset must be disclosed.

• The following information is required:

- A brief description of the nature of the contingent asset

- An estimate of the financial effect

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Disclosures

NOTE

For both contingent assets and contingent liabilities, these disclosures

may be avoided on the grounds that it is impractical to provide the
information or would be seriously prejudicial to the entity

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Thank you!