|
Recognition
IFRS set out three main criteria that must be met
to recognise a provision. These criteria, which
are essentially those established in the Framework
for liabilities generally, are as follows [IAS37R.14(a)-(c)]:
| a) |
an entity has a
present obligation (legal or constructive) as
a result of a past event; |
|
| b) |
it is probable that an outflow of resources
embodying economic benefits will be required
to settle the obligation; and |
|
| c) |
a reliable estimate can be
made of the amount of the obligation. |
Present obligation
Fundamental to the recognition of provisions is
the identification of past events that give rise
to present obligations (obligating events). An obligating
event is one that results in an obligation that
must be settled, regardless of management's actions
[IAS37R.10,17(a)-(b), 19]. Plans to incur expenditure,
which can be avoided, future operating losses and
forecasts of bad debts or impaired assets that may
not materialise are not obligating events .
The identification of past events where settlement
is enforceable under a legal agreement (legal obligations),
such as a lease and warranties, is usually straight-forward
.
The existence of laws and regulations, however,
do not automatically imply an obligating event.
An entity aware of a particular law may choose to
avoid its impact by making changes to its operations
[IAS37R.19] .
A past event, such as site contamination that does
not give rise to a legal obligation immediately,
may do so at a later date when for example legislation
is enacted. When the legislation is virtually certain
to be enacted, then the obligation should be treated
as a legal obligation [IAS37R.21] .
Past events, and the actions of management, which
raise valid expectations in other parties, give
rise to constructive obligations [IAS37R.17(b)].
For example, an entity may publish its intention
as a good corporate citizen to clean up site contamination,
raising an expectation that it will do so. Management
does not need to specifically identify the "expectant"
party; rather it must communicate its intentions,
and as a result cannot avoid meeting the obligation
.
Possible obligations rather than present obligations
are disclosed as contingent liabilities [IAS37R.13(a)-(b),
28].
Probable outflow of resources
An outflow of resources or other event is regarded
as probable if the event is more likely than not
to occur [IAS37R.23]. The more-likely-than-not interpretation
suggests that a likelihood assessed at above 50
per cent qualifies for recognition. Many provisions
relate to complex fact patterns for which assessments
of likelihood are judgmental and not susceptible
to precise determination;].
Initial measurement
Management should first give recognition to provisions
as liabilities using the gross amount. Anticipated
gains, for example, on the disposal of assets are
not taken into account in measuring a provision
[IAS37R.51]. The standard provides specific guidance
about reimbursements such as insurance recoveries,
requiring the recognition of a separate asset for
the recovery and permitting offset against the provision
in only limited circumstances.
Best estimate
IFRS require recognition of the best estimate of
the amount that would be required to settle an obligation
[IAS37R.36]. The estimate may be based on information
that produces a range of amounts. Where each point
within that range is equally likely, IFRS require
that the mid-point of the range be used. [IAS37R.39]
The measurement is to be on a present value basis
[IAS37R.45]. Required disclosures in IFRS will help
a reader of the financial statements to understand
the uncertainties inherent in such estimates .
IFRS require an expected value measurement, where
all possible outcomes are weighted by their associated
probabilities, where a provision relates to a large
population of items [IAS37R.39]. This methodology
is well accepted and produces a sensible result
for a population of numerous items, each with similar
characteristics, but becomes less appropriate as
the number or homogeneity of the items reduces .
Future events
Events such as changes in technology and new legislation
may affect the amount required to settle a liability.
These events should be reflected in the measurement
of a provision if there is sufficient objective
evidence that they will occur [IAS37R.48].
Discounting
IFRS require that where the effect of the time value
of money is material, the amount of a provision
should be the present value of the expenditures
required to settle the obligation [IAS37R.45]. The
appropriate discount rate is a nominal, pre-tax
rate that reflects the risks specific to the liability,
except where future cash-flows have already been
adjusted for risk [IAS37R.47] .
A provision's carrying amount increases in each
period to reflect the passage of time, where discounting
is used. The imputed interest for the period should
be recognised as borrowing cost [IAS37R.60] .
Subsequent measurement
The measurement rule must be reapplied at each
balance sheet date. The estimate of the liability
should therefore be updated at each balance sheet
date [IAS37R.59].
IFRS put important constraints on the utilisation
of provisions. Provisions are to be used only for
the expenditures for which they were established,
and reversed when they are no longer required for
that particular expenditure [IAS37R.61]. They cannot
be held as a general reserve to be applied against
some other unrelated expenditure. Where the initial
provision was charged to expense, any subsequent
reversal will be credited to the same line in the
income statement to properly reflect the substance
of the credit [IAS1R.34] [IAS8R36] .
However, where the provision had initially been
recognised as part of the cost of an asset (for
instance, as in the case of site restoration costs),
the reversal should reduce the asset's carrying
amount, allowing for any accumulated depreciation
or amortisation and accretion of discount.
Specific applications
Onerous contracts
The term onerous contract describes a contract where
the unavoidable costs of meeting the obligations
exceed the expected benefits . IFRS
require recognition of the present obligation under
an onerous contract [IAS37R.66].
The reference to unavoidable costs plays a significant
role in the measurement of these obligations. This
cost is the lower of the cost of: exiting the contract,
or continuing to fulfil it [IAS37R.68].
IFRS require that before a separate provision for
an onerous contract can be made, management should
recognise any impairment that has occurred on assets
dedicated to that contract [IAS37R.69] .
Restructuring activities
IFRS define a restructuring as a programme that
is [IAS37R.10]:
| a) |
planned and controlled
by management; and |
|
| b) |
materially changes either the scope of
a business or the manner in which that business
is conducted. |
The characteristics of an obligating event for
a restructuring are specified in IFRS as [IAS37R.72(a)-(b)]:
| a) |
a detailed formal
plan identifying key features of the plan and
its implementation; and |
|
| b) |
a valid expectation on the part of those
affected, either by starting to implement
the plan or announcing its main features to
those affected by it, such as customers, suppliers,
employees or trade unions. |
Considerable judgment is required to determine
whether an obligating event has occurred. All the
available evidence must be assessed to determine
whether a plan is detailed enough to create a valid
expectation in others. IFRS do not specify the maximum
period that may elapse either prior to the implementation
or to completion of the plan. However, plans to
be executed quickly will raise the expectation of
management's commitment to the restructure [IAS37R.74].
Both the formal plan condition and the valid expectation
condition must be met as at the balance sheet date
before a restructuring provision is recognised [IAS37R.72]
. A management or even a board decision
taken before the balance sheet date, coupled with
implementation or announcement after the balance
sheet date and before the financial statements are
finalised, are not sufficient to recognise a provision.
The latter case would require disclosures under
IFRS as a non-adjusting subsequent event [IAS37R.75]
.
IFRS provide important guidance on what is included
in a restructuring provision. Qualifying expenditures
are restricted to those incurred as a direct consequence
of the restructuring [IAS37R.80] .
IFRS are clear that no obligation arises for the
sale of an operation until the entity is committed
to the sale, that is, there is a binding sale agreement
[IAS37R.78].
De-recognition
Provisions are to be reversed when they are no longer
required for a particular expenditure, or when the
obligation provided for is met [IAS37R.59].
Presentation and disclosure
An entity must present provisions as a line item
on the face of the balance sheet [IAS1R.68(k)].
An entity must disclose in the notes to the financial
statements [IAS37R.84,85]:
| a) |
for each class
of provision, carrying amounts, additions, amounts
used and amounts reversed; |
|
| b) |
a brief description of the obligation,
timing and uncertainty of outflows and expected
reimbursements; |
|
| c) |
separate disclosure of the
effect of any change in the discount rate; |
|
| d) |
the nature of disputes (if
any) which prevent the disclosure of information
about provisions generally. |
Certain of the required disclosures may be omitted
if their inclusion in the financial statements would
be seriously prejudicial to the entity's interests. A statement that the seriously
prejudicial exemption has been taken should be given
where applicable [IAS37R.92].
|
