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IAS 37 Provisions, contingent liabilities and contingent claims
IAS 37 Provisions, contingent liabilities and contingent claims deals with accounting for provisions (liabilities with uncertain timing and amount), contingent assets (possible assets) and contingent liabilities (possible liabilities and current obligations that are not likely and cannot be measured reliably). Provisions are valued using the best estimate (including risks and uncertainties) of the expenses that will be required to settle the liability, based on the time value of money.
IAS 37 was issued in September 1998 and is to be applied to reporting periods beginning on or after July 1, 1999.
History of IAS 37
Standard draft E59 Provisions, contingent liabilities and contingent claims
IAS 37 Provisions, contingent liabilities and contingent claims
July 1, 1999
Date of entry into force of IAS 37 (1998)
|June 30, 2005||Draft fundamental revision of IAS 37, which was not finalized|
|May 14, 2020||changed byOnerous contracts - costs of fulfilling a contract (amendments to IAS 37)|
|January 1, 2022||Date of entry into force of the changes from May 2020|
Changes planned by the IASB
Summary of IAS 37
The aim of IAS 37 is to ensure that appropriate recognition criteria and valuation bases are applied to provisions, contingent liabilities and contingent assets. In addition, it should be ensured that sufficient information is disclosed in the notes to the financial statements to enable the addressees to understand their type, timing and amount. The standard is based on the principle that provisions may only be formed if there is a liability, i.e. if there is a current obligation from a past event. Thus, the standard aims to ensure that only real obligations are reflected in the financial statements - planned future expenses, even if approved by the board of directors or a similar body, are excluded from the approach.
scope of application
IAS 37 excludes obligations, contingent liabilities and contingent assets that result from the following issues: [IAS 37.1]
Provision: A debt that is uncertain as to its due date or amount.
fault: Current obligation of the company that arises from past events, the fulfillment of which is expected to result in an outflow of resources with economic benefit for the company (payment)
- A possible obligation whose existence is further confirmed by the occurrence or non-occurrence of one or more uncertain future events, or
- A present obligation for which payment is not likely or the amount of the obligation cannot be reliably estimated.
- Possible asset resulting from past events, and
- the existence of which is confirmed by the occurrence or non-occurrence of one or more uncertain future events that are not entirely under the company's control.
Recognition of a provision
An entity must recognize a provision if, and only if: [IAS 37.14]
- it has a present obligation (legal or factual) from a past event (the obligatory event);
- a payment is likely (more reasons for it than against it), and
- the amount can be reliably estimated.
A compulsory event is an event that creates a legal or constructive obligation that leaves the company with no realistic alternative to fulfilling the obligation. [IAS 37.10]
A de facto obligation arises when the usual business conduct has aroused a legitimate expectation towards other parties. For example, a department store (whose business policy has been around for a long time) allows the customer to return the goods, e.g. within 30 days. [IAS 37.10]
A possible obligation (contingent liability) must be stated in the notes; no provision is to be formed. However, information in the notes is not required if payment is unlikely. [IAS 37.86]
There are isolated cases, e.g. in a legal dispute, in which it is unclear whether a current obligation exists. In these cases, a past event leads to a current obligation if, taking into account all available substantial indications for the existence of a current obligation on the balance sheet date, there is more for it than against it. A provision must be recognized for this current obligation if the other recognition criteria outlined above are met. If there are more reasons for it than against the fact that there is no present obligation, the company must disclose a contingent liability unless the possibility of an outflow of resources is unlikely. [IAS 37.15]
Valuation of provisions
The amount recognized as a provision represents the best possible estimate of the expenditure required to meet the current obligation on the balance sheet date. The best possible estimate of the amount required to fulfill the current obligation is the amount that the company would reasonably have to pay to fulfill the obligation on the balance sheet date or to transfer the obligation to a third party on that date. [IAS 37.36] This means:
- Provisions for one-off events (restructuring, removal of environmental damage, settlement of a legal dispute) are recognized at the most probable amount. [IAS 37.40]
- Provisions for a large number of events (warranties, reimbursements to customers) are recognized at the expected value. [IAS 37.39]
- Both valuations are discounted to their present value using a pre-tax interest rate that reflects current market expectations with regard to the time value of money and the risks specific to the liability. [IAS 37.45 and IAS 37.47]
In making the best possible estimate of a provision, the company must consider the inevitable risks and uncertainties associated with many events and circumstances. The expected cash flows are discounted to their present value if the effects of the time value of money are material. [IAS 37.42]
If it is expected that the expenses required to meet a deferred obligation will be reimbursed in whole or in part by another party, the reimbursement should only be recognized if it is virtually certain that the company will receive the reimbursement when the obligation is met. The reimbursement should be treated as a separate asset. The amount stated for the reimbursement may not exceed the amount of the provision. [IAS 37.53]
When evaluating a provision, future events must be taken into account as follows:
- Planning of justifiable changes in the use of existing technologies [IAS 37.48]
- No inclusion of possible profits from the sale of assets [IAS 37.51]
- Consideration of changes in the law only if the passage of the law is almost certain [IAS 37.50]
Adjustments to provisions
- Provisions must be checked and adjusted on each balance sheet date
- If an outflow is no longer probable, the provision is to be released through profit or loss.
Some examples of provisions
Formation of a provision?
Restructuring through the sale of a business unit
A provision may only be formed after a binding purchase contract has been concluded
Restructuring through shutdown or reorganization
A provision may only be formed after a detailed formal plan has been approved and publicly announced. A decision by the board of directors is not enough
A provision must be created (event in the past was the sale of defective goods)
A provision shall be made if it is the company's business conduct to remove the pollution, even if it has no legal obligation to do so (past event was the public's obligation and expectation generated by the company's conduct )
Refunds to customers
A provision should be made if it is normal business practice to issue a refund (past event is the customer's expectation at the time of purchase that a refund will be possible)
An off-shore oil rig needs to be removed and the seabed rebuilt
A provision is to be created upon construction, which is added to the acquisition or production costs at the same time
Disused rental property with a rental period of 4 years
A provision must be made
A securities company must train its employees in order to bring them up to date due to current changes in tax law
No provision (there is no obligation to enable this training measure)
A chain of department stores has no insurance cover in the event of fire damage
No provision until an actual fire (not a past event)
Self-insured restaurant where guests poisoned themselves; litigation is expected, but no lawsuits have been filed to date
A provision is to be made (the event of the past is the injury to the guests)
General overhaul or major repairs
No provision (no obligation)
Onerous (loss-making) contracts
A provision must be made
A restructuring measure is: [IAS 37.70]
- Sale of a line of business: A provision may only be set up after a binding purchase agreement has been concluded. [IAS 37.78] If the binding purchase agreement was only concluded after the balance sheet date, information must be given in the notes, but no provision may be made.
- Shutdown or reorganization: A provision is only to be made after adoption and public announcement. A decision by the board of directors is not enough.
- Future operating losses: Provisions for future operating losses may not be made, even in the event of a restructuring measure.
- Restructuring provisions (for company acquisitions): Under the regulation of IAS 22, a provision for the termination of employees, for the closure of production facilities and for the discontinuation of product lines was only to be formed if this was announced at the time of acquisition and only if a formal plan was adopted within 3 months of acquisition. According to IFRS 3, a provision for restructuring measures in the course of a company acquisition can only be recognized if it should have already been recognized in the separate financial statements of the acquired company. The approach criteria described above apply here.
Restructuring provisions may only include expenses directly caused by the restructuring, not expenses related to the company's ongoing activities. [IAS 37.80]
Opposite item to the provision posting
If a provision (liability) is recognized, the offsetting entry does not necessarily have to be recognized in profit or loss. In certain cases, the provision can become part of the cost of an asset. Examples: Obligation to clean up pollution when opening a new mine or building an offshore oil rig. [IAS 37.8]
Consumption of provisions
Provisions may only be used for the purpose for which they were originally created. They must be reviewed and adjusted on each balance sheet date to reflect the current best possible estimate. If it no longer appears likely that the fulfillment of the obligation will require an outflow of resources, then the provision must be released. [IAS 37.61]
Since there is a general concern about uncertain debt, IAS 37 also addresses contingent liabilities. The standard stipulates that companies are not allowed to record any contingent liabilities. However, information must be given in the appendix as long as the possibility of an outflow of resources is not unlikely. [IAS 37.86]
Contingent claims may not be recognized - but they must be stated in the notes if the inflow of economic benefit is probable. However, if the realization of income is almost certain, the asset in question is no longer to be viewed as a contingent asset and its recognition is appropriate. [IAS 37.31]
Reconciliation for each group of provisions: [IAS 37.84]
- Opening balance
- Consumption (amounts posted against the provision)
- Impact of the time value of money
- Closing stock
A reconciliation for the previous year is not required. [IAS 37.84]
For each group of provisions, a brief description must be given for: [IAS 37.85]
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