13 Provisions Flashcards
Under IAS 37 a provision should be recognised when:
An entity has a present obligation, legal or constructive It is probable that a transfer of resources embodying economic benefits will be required to settle it A reliable estimate can be made of its amount
What does IAS 37 Provisions, contingent liabilities and contingent assets aim to ensure?
IAS 37 Provisions, contingent liabilities and contingent assets aims to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.
What is a provision? what is a liability?
A provision is a liability of uncertain timing or amount. A liability is 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.
Recognition IAS 37 states that a provision should be recognised as a liability in the financial statements when:
An entity has a present obligation (legal or constructive) as a result of 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
Meaning of obligation It is fairly clear what a legal obligation is. However, you may not know what a constructive obligation is. IAS 37 defines a constructive obligation as:
‘An obligation that derives from an entity’s actions where: 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 as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.’
For the purpose of the IAS, a transfer of resources embodying economic benefits is regarded as ‘probable’ if the event is more likely than not to occur. This appears to indicate a probability of more than 50%. However, the standard makes it clear that where there is a number of similar obligations the probability should be based on considering the population as a whole, rather than one single item. True/ False
For the purpose of the IAS, a transfer of resources embodying economic benefits is regarded as ‘probable’ if the event is more likely than not to occur. This appears to indicate a probability of more than 50%. However, the standard makes it clear that where there is a number of similar obligations the probability should be based on considering the population as a whole, rather than one single item.
The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The estimates will be determined by the judgement of the entity’s management supplemented by the experience of similar transactions. True/ False
The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.The estimates will be determined by the judgement of the entity’s management supplemented by the experience of similar transactions.
Where the effect of the time value of money is material, the amount of a provision should be the Future value of the expenditure required to settle the obligation. An appropriate discount rate should be used. The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money. The discount rate(s) should not reflect risks for which future cash flow estimates have been adjusted. True/ False
Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditure required to settle the obligation. An appropriate discount rate should be used. The discount rate should be a pre-tax rate that reflects current market assessments of the time value of money. The discount rate(s) should not reflect risks for which future cash flow estimates have been adjusted
Reimbursements Some or all of the expenditure needed to settle a provision may be expected to be recovered from a third party. If so, the reimbursement should be recognised only when it is virtually certain that reimbursement will be received if the entity settles the obligation. How should reimbursement be treated and recognised.
The reimbursement should be treated as a separate asset, and the amount recognised should not be greater than the provision itself. The provision and the amount recognised for reimbursement may be netted off in profit or loss.
Use of provisions A provision should be used only for expenditures for which the provision was originally recognised. Setting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events. True/ False
Use of provisions A provision should be used only for expenditures for which the provision was originally recognised. Setting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.
Future operating losses: Use of provisions A provision should be used only for expenditures for which the provision was originally recognised. Setting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events. true/ False
Future operating losses: Provisions should not be recognised for future operating losses. They do not meet the definition of a liability and the general recognition criteria set out in the standard.
What is an onerous contract?
An onerous contract is a contract entered into with another party under which the unavoidable costs of fulfilling the terms of the contract exceed any revenues expected to be received from the goods or services supplied or purchased directly or indirectly under the contract and where the entity would have to compensate the other party if it did not fulfil the terms of the contract.
Examples of possible provisions It is easier to see what IAS 37 is driving at if you look at examples of those items which are possible provisions under this standard. Some of these we have already touched on.
Warranties. These are argued to be genuine provisions as on past experience it is probable, ie more likely than not, that some claims will emerge. The provision must be estimated, however, on the basis of the class as a whole and not on individual claims. There is a clear legal obligation in this case Major repairs. Self insurance Environmental contamination Decommissioning or abandonment costs. Restructuring
Provisions for restructuring One of the main purposes of IAS 37 was to target abuses of provisions for restructuring. Accordingly, IAS 37 lays down strict criteria to determine when such a provision can be made. IAS 37 defines a restructuring as:
A programme that is planned and is controlled by management and materially changes one of two things. The scope of a business undertaken by an entity The manner in which that business is conducted
The IAS gives the following examples of events that may fall under the definition of restructuring.
The sale or termination of a line of business The closure of business locations in a country or region or the relocation of business activities from one country region to another Changes in management structure, for example, the elimination of a layer of management Fundamental reorganisations that have a material effect on the nature and focus of the entity’s operations
The question is whether or not an entity has an obligation – legal or constructive – at the end of the reporting period. For this to be the case:
An entity must have a detailed formal plan for the restructuring. It must have 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.