IAS 12
Provisions, contingent liabilities and contingent assets 1873
Leases (unless onerous)
•
IAS 17 /
IFRS 16
Employee benefits
•
IAS 19
Insurance contracts issued by insurers to policyholders
•
IFRS 4 /
IFRS 17
Contingent liabilities acquired in a business combination
•
IFRS 3
Contingent consideration of an acquirer in a business
•
IFRS 3
combination
Financial instruments and financial guarantees within the
•
IFRS 9
scope of IFRS 9
Trade payables
•
IFRS 9
Accruals
•
2.2.1
Items outside the scope of IAS 37
2.2.1.A
Executory contracts, except where the contract is onerous
The standard uses the term executory contracts to mean ‘contracts under which neither
party has performed any of its obligations, or both parties have partially performed their
obligations to an equal extent’. [IAS 37.3]. This means that contracts such as supplier
purchase contracts and capital commitments, which would otherwise fall within the
scope of the standard, are exempt.
This exemption prevents the statement of financial position from being grossed up for
all manner of commitments that an entity has entered into, and in respect of which it is
debatable whether (or at what point) such contracts give rise to items that meet the
definition of a liability or an asset. In particular, the need for this exemption arises
because the liability framework on which this standard is based includes the concept of
a constructive obligation (see 3.1.1 below) which, when applied to executory contracts
would otherwise give rise to an inordinate number of contingent promises requiring
recognition or disclosure.
An executory contract will still require recognition as a provision if the contract
becomes onerous. [IAS 37.3]. Onerous contracts are dealt with at 6.2 below.
2.2.1.B
Items covered by another standard
Where another standard deals with a specific type of provision, contingent liability
or contingent asset, it should be applied instead of IAS 37. Examples given in the
standard are:
• income taxes (dealt with in IAS 12 – Income Taxes – see Chapter 29);
• leases (dealt with in IFRS 16 – Leases – see Chapter 24). However, IAS 37 applies
to any lease that becomes onerous before the commencement date of the lease,
as defined in IFRS 16. IAS 37 also applies to onerous short-term leases and
onerous leases of low value assets that are accounted for under paragraph 6 of
IFRS 16. [IAS 37.5(c)]. For entities not yet applying IFRS 16, leases are dealt with in
1874 Chapter 27
IAS 17 – Leases – see Chapter 23. However, for entities applying IAS 17 rather
than IFRS 16, IAS 37 states that if operating leases become onerous, there are no
specific requirements within IAS 17 to address the issue and thus IAS 37 applies
to such leases);
• employee benefits (dealt with in IAS 19 – Employee Benefits – see Chapter 31);
• insurance contracts dealt with in IFRS 4 – Insurance Contracts – see Chapter 51,
or insurance and other contracts in scope of IFRS 17 – Insurance Contracts – if
that standard has been adopted (see Chapter 52). However, IAS 37 requires an
insurer to apply the standard to provisions, contingent liabilities and contingent
assets, other than those arising from its contractual obligations and rights under
insurance contracts within the scope of IFRS 4, or IFRS 17 if that Standard has
been adopted;
• contingent consideration of an acquirer in a business combination (dealt with in
IFRS 3 – Business Combinations – see Chapter 9); and
• revenue from contracts with customers (dealt with in IFRS 15 – Revenue from
Contracts with Customers – see Chapter 28). However, as IFRS 15 contains no
specific requirements to address contracts with customers that are, or have
become, onerous, IAS 37 applies to such cases. [IAS 37.5].
Contingent consideration of an acquirer in a business combination is excluded from the
scope of IAS 37 as a result of changes to IFRS 3 effective for business combinations with
an acquisition date on or after 1 July 2014. See Chapter 9 at 7.1.
As noted above, the scope of IAS 37 excludes income taxes that fall in the scope of
IAS 12. The Interpretations Committee confirmed in July 2014 that the recognition of
tax-related contingent liabilities and contingent assets should also be assessed using the
guidance in IAS 12 rather than IAS 37.2 In addition, IFRIC 23 – Uncertainty over Income
Tax Treatments – was issued in June 2017 and clarifies how to apply the recognition
and measurement requirements in IAS 12 when there is uncertainty over tax treatments.
[IFRIC 23.4]. IAS 37 remains relevant to the disclosure of tax-related contingent liabilities
and contingent assets. [IAS 12.88]. However, as discussed at 6.8 below, IAS 37 in general
and IFRIC 21 in particular, applies to taxes or levies outside the scope of IAS 12. As
regards interest and penalties imposed by taxation authorities the position is unclear.
Neither IAS 12 nor IFRIC 23 contain a specific reference to interest and penalties, and,
in September 2017, the Interpretations Committee decided not to add a project on
interest and penalties to its agenda.3 However, notwithstanding their decision to exclude
interest and penalties from the scope of IFRIC 23 and their decision not to add a project
on interest and penalties to its agenda, the Interpretations Committee observed that if
an entity determines that amounts payable or receivable for interest and penalties are
income taxes, then the entity applies IAS 12 to those amounts. If an entity does not apply
IAS 12 to interest and penalties, then it applies IAS 37 to those amounts. Uncertain tax
treatments are discussed further in Chapter 29 at 9. The circumstances in which interest
and penalties might fall within the scope of IAS 12 are considered in Chapter 29 at 4.4.
Levies imposed by governments are examined at 6.8 below.
Provisions, contingent liabilities and contingent assets 1875
Whilst IAS 37 contains no reference to it, IFRS 3 states that the requirements in IAS 37
do not apply in determining which contingent liabilities to recognise as of the
acquisition date (see 4.10 below and Chapter 9 at 5.6.1). [IFRS 3.23].
In addition, the standard does not apply to financial instruments (including guarantees)
that are within the scope of IFRS 9 – Financial Instruments. [IAS 37.2]. This means that
guarantees of third party borrowings (including those of subsidiaries, associates and joint
arrangements) are not covered by IAS 37. However, the guarantee contract may meet
the definition of an insurance contract in IFRS 4 and the issuer may have previously
asserted that it regards such contracts as insurance contracts. In such cases, the issuer
may elect to apply either IFRS 9 (or, for annual reporting periods beginning before
1 January 2021, IAS 39 – Financial Instruments: Rec
ognition and Measurement, for
those entities whose predominant activity is issuing contracts in scope of IFRS 4 and
who previously have not applied any version of IFRS 9 [IFRS 4.20A, 20B]) or IFRS 4
[IFRS 9.2.1(e)] and the accounting policy applied by the issuer may result in the issuer
providing for probable payments under the guarantee. A similar accounting policy
choice exists for entities that apply IFRS 17, [IFRS 17.7(e)], although entities applying
IFRS 17 do not have the option to apply IAS 39 rather than IFRS 9. (See Chapter 51 for
IFRS 4 and Chapter 52 for IFRS 17).
The standard applies to provisions for restructurings, including discontinued operations.
However, it emphasises that when a restructuring meets the definition of a discontinued
operation under IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations, additional disclosures may be required under that standard (see Chapter 4
at 3). [IAS 37.9].
As noted above, IAS 37 applies to contracts in scope of IFRS 15 that are, or have
become, onerous. [IAS 37.5(g)]. IFRS 15 adds that IAS 37 applies to other obligations
under a contract with a customer that do not give rise to a performance obligation.
For example, a law that requires an entity to pay compensation if its products cause
harm or damage does not give rise to a performance obligation and IAS 37 would
apply. Similarly, an entity would account for customer indemnities arising from claims
of patent, copyright, trademark or other infringement in relation to its products in
accordance with IAS 37. [IFRS 15.B33]. Furthermore, whilst an entity would apply
IFRS 15 to separately purchased warranties, if a customer does not have the option to
purchase a warranty separately, an entity would consider IAS 37 (see 6.10 below),
unless the promised warranty, or a part of the promised warranty, provides the
customer with a service in addition to the assurance that the product complies with
agreed-upon specifications. [IFRS 15.B30].
The standard defines a provision as ‘a liability of uncertain timing or amount’. [IAS 37.10].
Thus it only deals with provisions that are shown as liabilities in a statement of financial
position. The term ‘provision’ is also used widely in the context of items such as
depreciation, impairment of assets and doubtful debts. Such ‘provisions’ are not
addressed in IAS 37, since these are adjustments to the carrying amounts of
assets. [IAS 37.7].
1876 Chapter 27
2.2.2
Provisions compared to other liabilities
IAS 37 states that the feature distinguishing provisions from other liabilities, such as trade
payables and accruals, is the existence of ‘uncertainty about the timing or amount of the
future expenditure required in settlement’. [IAS 37.11]. The standard compares provisions to:
(a) trade payables – liabilities to pay for goods or services that have been received or
supplied and have been invoiced or formally agreed with the supplier; and
(b) accruals – liabilities to pay for goods or services that have been received or
supplied but have not been paid, invoiced or formally agreed with the supplier,
including amounts due to employees (for example, amounts relating to accrued
vacation pay). Although it is sometimes necessary to estimate the amount or timing
of accruals, the uncertainty is generally much less than for provisions.
IAS 37 also notes that accruals are often reported as part of trade and other payables
whereas provisions are reported separately. [IAS 37.11].
For trade payables and their associated accruals, there is little uncertainty regarding
either the amount of the obligation (which would be determined by the contracted price
for the goods and services being provided) or of the timing of settlement (which would
normally occur within an agreed period following transfer of the goods and services in
question and the issue of an invoice). In practice, however, contracts can be more
complex and give rise to a wide range of possible outcomes in terms of the amount or
timing of payment. In these circumstances, the difference between provisions and other
liabilities is less obvious and judgement may be required to determine where the
requirement to make an estimate of an obligation indicates a level of uncertainty about
timing or amount that is more indicative of a provision. Such judgements, if significant
to the amounts recognised in the financial statements, would merit disclosure (see
Chapter 3 at 5.1.1.B). [IAS 1.122].
One reason why this distinction matters is that provisions are subject to narrative
disclosure requirements regarding the nature of the obligation and the uncertainties
over timing and amount; and to quantitative disclosures of movements arising from their
use, remeasurement or release that do not apply to other payables (see 7.1 below). In
fact, although questions of recognition and measurement are important, transparency
of disclosure is also a very significant matter in relation to accounting for provisions and
ensuring that their effect is properly understood by users of the financial statements.
2.2.3
Distinction between provisions and contingent liabilities
There is an area of overlap between provisions and contingent liabilities. Although
contingent liabilities are clearly not as likely to give rise to outflows, similar judgements
are made in assessing the nature of the uncertainties, the need for disclosures and
ultimately the recognition of a liability in the financial statements. The standard notes
that in a general sense, all provisions are contingent because they are uncertain in timing
or amount. However, in IAS 37 the term ‘contingent’ is used for liabilities and assets that
are not recognised because their existence will be confirmed only by the occurrence of
one or more uncertain future events not wholly within the entity’s control. In addition,
the term ‘contingent liability’ is used for liabilities that do not meet the recognition
criteria for provisions. [IAS 37.12].
Provisions, contingent liabilities and contingent assets 1877
Accordingly, the standard distinguishes between:
(a) provisions – which are recognised as liabilities (assuming that a reliable estimate
can be made) because they are present obligations and it is probable that an
outflow of resources embodying economic benefits will be required to settle the
obligations; and
(b) contingent liabilities – which are not recognised as liabilities because they are
either:
(i) possible obligations, as it has yet to be confirmed whether the entity has a
present obligation that could lead to an outflow of resources embodying
economic benefits; or
(ii) present obligations that do not meet the recognition criteria in the standard
because either it is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation, or a sufficiently
reliable estimate of the amount of the obligation cannot be made. [IAS 37.13].
3 RECOGNITION
3.1
Determining when a provision should be recognised
IAS 37 requires that a provision should be recognised when:
(a) an entity has a present obligation (legal or constructive) as a re
sult 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.
No provision should be recognised unless all of these conditions are met. [IAS 37.14].
Each of these three conditions is discussed separately below.
3.1.1
‘An entity has a present obligation (legal or constructive) as a result
of a past event’
The standard defines both legal and constructive obligations. The definition of a legal
obligation is fairly straightforward and uncontroversial; it refers to an obligation that
derives from a contract (through its explicit or implicit terms), legislation or other
operation of law. [IAS 37.10].
The definition of a constructive obligation, on the other hand, may give rise to more
problems of interpretation. A constructive obligation is defined as an obligation that
derives from an entity’s actions where:
(a) 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
(b) as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities. [IAS 37.10].
The following examples in IAS 37 illustrate how a constructive obligation is created.
1878 Chapter 27
Example 27.1: Recognising a provision because of a constructive obligation
Scenario 1: Environmental policy – contaminated land
An entity in the oil industry operates in a country with no environmental legislation. However, it has a widely
published environmental policy in which it undertakes to clean up all contamination that it causes and it has a record
of honouring this published policy. During the period the entity causes contamination to some land in this country.
In these circumstances, the contamination of the land gives rise to a constructive obligation because the entity
(through its published policy and record of honouring it) has created a valid expectation on the part of those
affected by it that the entity will clean up the site. [IAS 37 IE Example 2B].
Scenario 2: Refunds policy – product returns
A retail store has a generally known policy of refunding purchases by dissatisfied customers, even though it
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 369
