TOPIC: IAS 37 PROVISIONS, CONTIGENT LIABILITIES AND CONTINGENT ASSETS
LEARNING OUTCOMES
The following key concepts are fundamental to this standard:
· The difference between provisions and contingent liabilities.
· The identification of a contingent asset.
· The difference between legal and constructive obligations.
· The recognition of provisions.
· The disclosure of contingent liabilities and assets.
· The recognition and disclosure of onerous contracts.
1. OBJECTIVES OF IAS 37
· To ensure proper recognition and measurement of provisions, contingent liabilities and contingent assets
· To ensure sufficient disclosure of information about provisions; their nature, timing and amount and uncertainties.
· Contingent assets and liabilities: Nature, amount and uncertainties.
2. Scope of IAS 37
The statement should be applied by all enterprises in accounting for provisions, contingent assets and contingent liabilities except;
· Those resulting from financial instruments that are carried at fair value(IFRS 9)
· Resulting from executor contracts except where the contract is onerous.
· Those arising in insurance enterprises from contracts with policy holders.
· Those covered by another IAS in which case the enterprise applies that statement e.g -- construction contracts IAS 11
- Income taxes IAS 12
- Leases IAS 17
- Employee benefits IAS 19
3. Key Definitions
(a) Provision
-this is a liability of uncertain timing and amount.
(b) Liability
-is a present obligation of an enterprise arising from past events settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
(c) An obligating event
- an event that creates a legal or a constructive obligation that results in an enterprise having no realistic alternative to settling that obligation.
(d) Legal obligation
-is an obligation that derives from;
(i) a contract
(ii) Legislation
(iii) Other operation of law
(e) Constructive obligation
- an obligation that derives from an enterprise actions where;
(i) by an established pattern of practice, published policies or a sufficiently specific current statement the enterprise has indicated to other parties that it will accept certain responsibilities.
(ii) As a result the enterprise has created a valid expectation on the part of other parties that it will discharge those responsibilities.
(f) Contingent liability (defined in 2 parts I and II)
I -is 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 enterprise or
II – is a present obligation that arises from past events but is not recognised because,
(a) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation
(b) The amount of the obligation cannot be measured with sufficient reliability.
(g) Contingent asset
- is a possible asset that arises from past events and whose existence would be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the enterprise.
(h) Onerous contract
- is a contract in which the unavoidable costs of meeting the obligations under the contract exceeds the economic benefits expected to be received under the contract.
(i) Executory contract (not covered by IAS 37)
- is a contract under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent and therefore no liability exists.
NB: IAS 37 does not apply to executory contracts
4. Recognition
(a) Provisions
- should be recognised when;
(i) An enterprise has a present obligation [legal or constructive] as a result of past events.
(ii) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
(iii) A reliable estimate can be made of the amount of the obligation.
NB
If all these conditions are not met, no provision should be recognised.
(b) Contingent liabilities
- an enterprise should not recognise a contingent liability. A contingent liability should be however, be disclosed unless possibility of an outflow is remote.
Note: Always monitor the circumstances.
(c) Contingent asset
-an entity should not recognise a contingent asset, but disclose it.
5. Measurement
(a) Best estimate (because of uncertainty)
-the amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the reporting date. The provision is measured before tax.
(b) Present value
- where the fact of the time value of money is material, the amount of the provision should be the present value of the expenditure expected to be required to settle the obligation. The discount rate should be a pre-tax rate that reflects current assessment of the time value of money.
Source of Information
• IAS 37
• Descriptive Accounting 17th Edition
• Advanced Corporate Reporting I UNISA Module 2014
• Opperman 14th Edition
ILLUSTRATIONS
QUESTION 1
Mighty Mouse Trap Company Ltd has just started with the export of mouse traps to the Mozambique. The advertising slogan for the mouse traps is: "A girl's best friend". The following claims have been instituted against the company during the year ended 28 February 20.11:
(a) Mr G Barnette lost his thumb while he was handling a mouse trap with an
extraordinarily strong spring. He is claiming $5 000 in respect of medical and other
costs. According to the company's legal representatives there is a good chance that the
claim will succeed. [6Marks]
(b) The Zimbamwean Women's Liberation Movement is claiming $10 000 from the company because the advertising slogan allegedly compromises women's dignity. The company's legal representatives are of the opinion that the success of the claim will depend on the judge which presides over the case. They however estimate that there is a 70% probability that the claim will be thrown out and a 30% probability that it will succeed. [5Marks]
(c) Mr Chinos claims $100 000 on the basis that his fear of mice is widely known and that the company's advertising slogan makes him appear feminine in the eyes of the general public. The company's legal representatives are of the opinion that the chance of the claim succeeding , is remote. [3marks]
2. Mighty Mouse Trap Company has an annual exhibition at the Zimbabwe International Trade Fair (ZITF). Sales at the exhibition for the year ended 28 February 2014 were $410 000. The directors decided that they will again have an exhibition at the show in April 2015. The stand is however bigger and therefore the rental will be considerably higher. The board of directors is of the opinion that a provision should be made for an operating loss in respect of the show’s activities which is expected to be incurred in April 2015. A provision of $120 000 has been made. [6Marks]
REQUIRED
Discuss how these matters should be accounted for and how it should be disclosed in its
financial statements for the year ended 28 February 2013.
HOW SHOULD I ATTEMPT THIS QUESTION?
1. Read the “REQUIRED” section carefully. The question indicates that you should
“discuss” how the different claims should be accounted for. In addition the question
requires you to disclose all the matters.
2. Note that the question counts only 20 marks. You cannot write pages on each claim.
Only provide relevant information.
3. Remember to come to a conclusion in each case. You should determine whether the
amount should be provided for or not. An amount should only be provided for if it
complies with the definition of a liability as well as the recognition criteria. Your
answer should cover the following aspects:
- Is there a present obligation as a result of past events?
- Will there be a probable outflow of economic benefits?
- Can the amount be estimated reliably?
- Come to a conclusion.
- Discuss the disclosure if applicable.