Lecture 13 - IAS37: Provisions, Contingent liabilities and assets

What is IAS 37 about?

Recognition, measurement and disclosure of provisions contingent liabilities and contingent assets

Why was IAS 37 introduced?

To stop profit manipulation and “big bath” provisions

What creates a provision under IAS 37?

Uncertainty of amount or occurrence of a future event

What are examples of provisions under IAS 37?

• Legal cases

• Reorganisation costs

• Cleaning up contamination

What problem existed before IAS 37?

Provisions used for creative accounting

What is the purpose of IAS 37?

Ensure only necessary provisions are recognised and properly measured

What else does IAS 37 prevent?

Unjustified provisions or excessive provisions

What else does IAS 37 regulate?

Contingent liabilities and assets

What else does IAS 37 require?

Clear disclosures of timings and amounts

What is a provision?

Liability of uncertain timing or amount

How does a provision link to liabilities?

Present obligation from past event with expected outflow

When is a provision recognised?

When all three criteria are met

What is the first recognition criterion?

Present obligation

What type of obligation is required?

Legal or constructive

What is the second recognition criterion?

Probable outflow greater than 50%

What is the third recognition criterion?

Reliable estimate of the obligation

What question helps decide provision?

Can the obligation be avoided

What if it cannot be avoided?

Recognise provision

What happens if obligation can be avoided?

No provision recognised

What is the key memory rule?

Possible disclose probable provide certain payable

What is a legal obligation?

Obligation from law or contract

What is a constructive obligation?

Obligations from past behaviour creating expectation

When is there no provision in clean-up example?

No legal requirement and no past behaviour

When legal requirement exists?

Provision

When consistent past clean-up behaviour?

Provision

How is a provision measured?

Best estimate of the cost required to settle obligation

What method is used for single obligation?

Most likely outcome

What method is used for multiple outcomes?

Expected value calculation

When are provisions discounted?

When time value of money is material

How is discounted provision measured?

Present value of future cash outflows

What does possible mean in IAS 37?

Disclose

What does probable mean in IAS 37?

Provide

What does certain mean in IAS 37?

Payable

What is a contingent liability?

Possible obligation or present obligation not recognised

When does a contingent liability arise?

From uncertain future events

Why are contingent liabilities not recognised?

Not probable or not measurable reliably

How are contingent liabilities treated?

Disclosed in notes

When are contingent liabilities not disclosed?

If outflow is remote

What is a contingent asset?

Possible asset from past events

When is a contingent asset recognised?

When inflow is virtually certain

When is a contingent asset disclosed?

When inflow is probable

What is key difference between provision and contingent liability?

Provision is probable contingent is possible

Are provisions recognised?

Yes - they are recognised

Are contingent liabilities recognised?

No - they are not recognised

Can future operating losses be recognised?

No - they are not recognised

Why are future losses not recognised?

No - present obligation exists

When is restructuring provision recognised?

When detailed plan and valid expectation exist

How is valid expectation created?

Start implementation or announce plan

What costs are included in restructuring provision?

Direct necessary restructuring costs only

What costs are excluded from restructuring provision?

Training marketing and new systems

When is sale obligation recognised?

Only when binding agreement exists

What is an onerous contract?

Contract where unavoidable costs exceed benefits (costs > benefits)

What must be recognised for onerous contracts?

Provision for unavoidable costs

What amount is recognised for onerous contract?

Least cost option available

What determines provision vs contingent liability?

Probability and measurability

What happens if obligation is probable and measurable?

Recognise provision

What happens if obligation is only possible?

Disclose contingent liability

Why is no provision recognised when lawsuit likely to be won?

Outflow is not probable or measurable

Why is provision recognised when lawsuit likely to be lost?

Outflow is probable and measurable