7,065
Revision to estimate
–
Year 3
115,762 115,762
In Year 2, the finance charge is based on the previous estimate of the discount rate and the revision to the
estimate of the provision would be charged to the same line item in the income statement that was used to
establish the provision of €93,184 at the start of Year 1.
Where market rates of interest are more volatile, entities may decide to reassess the
applicable discount rate for a provision during an annual reporting period. Equally, it
Provisions, contingent liabilities and contingent assets 1897
would be appropriate to revise this assessment as at the end of any interim reporting
period during the financial year to the extent that the impact is material.
4.4
Anticipating future events that may affect the estimate of cash
flows
The standard states that ‘future events that may affect the amount required to settle an
obligation shall be reflected in the amount of a provision where there is sufficient
objective evidence that they will occur’. [IAS 37.48]. The types of future events that the
standard has in mind are advances in technology and changes in legislation.
The requirement for objective evidence means that it is not appropriate to reduce the best
estimate of future cash flows simply by assuming that a completely new technology will be
developed before the liability is required to be settled. There will need to be sufficient
objective evidence that such future developments are likely. For example, an entity may
believe that the cost of cleaning up a site at the end of its life will be reduced by future
changes in technology. The amount recognised has to reflect a reasonable expectation of
technically qualified, objective observers, taking account of all available evidence as to the
technology that will be available at the time of the clean-up. Thus it is appropriate to
include, for example, expected cost reductions associated with increased experience in
applying existing technology or the expected cost of applying existing technology to a
larger or more complex clean-up operation than has previously been carried out. [IAS 37.49].
Similarly, if new legislation is to be anticipated, there will need to be evidence both of
what the legislation will demand and whether it is virtually certain to be enacted and
implemented. In many cases sufficient objective evidence will not exist until the new
legislation is enacted. [IAS 37.50].
These requirements are most likely to impact provisions for liabilities that will be settled
some distance in the future, such as decommissioning costs (see 6.3 below).
4.5
Provisions that will be settled in a currency other than the
entity’s functional currency
Entities may sometimes expect to settle an obligation in a currency other than their
functional currency. In such cases, the provision would be measured in the currency in
which settlement is expected and then discounted using a discount rate appropriate for
that currency. This approach is consistent with that required by IAS 36 – Impairment of
Assets – for foreign currency cash flows in value in use calculations. [IAS 36.54]. The present
value would be translated into functional currency at the spot exchange rate at the date at
which the provision is recognised. [IAS 21.21]. If the provision is considered to be a monetary
liability, i.e. it is expected to be paid in a fixed or determinable number of units of currency,
[IAS 21.8], it would thereafter be retranslated at the spot exchange rate at each reporting date.
[IAS 21.23]. In most cases, exchange differences arising on provisions will be taken to profit
or loss in the period in which they arise, in accordance with the general rule for monetary
items in IAS 21 – The Effects of Changes in Foreign Exchange Rates. [IAS 21.28].
Exchange differences arising on decommissioning provisions recognised under IAS 37 and
capitalised as part of the cost of an asset under IAS 16 are considered in Chapter 39 at 10.2.
1898 Chapter 27
4.6
Reimbursements, insurance and other recoveries from third parties
In some circumstances an entity is able to look to a third party to reimburse part of the
costs required to settle a provision or to pay the amounts directly to a third party.
Examples are insurance contracts, indemnity clauses and suppliers’ warranties.
[IAS 37.55]. A reimbursement asset is recognised only when it is virtually certain to be
received if the entity settles the obligation. The asset cannot be greater than the amount
of the provision. No ‘netting off’ is allowed in the statement of financial position, with
any asset classified separately from any provision. [IAS 37.53]. However, the expense
relating to a provision can be shown in the income statement net of reimbursement.
[IAS 37.54]. This means that if an entity has insurance cover in relation to a specific
potential obligation, this is treated as a reimbursement right under IAS 37. It is not
appropriate to record no provision (where the recognition criteria in the standard are
met) on the basis that the entity’s net exposure is expected to be zero.
The main area of concern with these requirements is whether the ‘virtually certain’
criterion that needs to be applied to the corresponding asset might mean that some
reimbursements will not be capable of recognition at all. For items such as insurance
contracts, this may not be an issue, as entities will probably be able to confirm the
existence of cover for the obligation in question and accordingly be able to demonstrate
that a recovery on an insurance contract is virtually certain if the entity is required to
settle the obligation. Of course, it may be more difficult in complex situations for an
entity to confirm it has cover against any loss. For other types of reimbursement, it may
be more difficult to establish that recovery is virtually certain.
Except when an obligation is determined to be joint and several (see 4.7 below), any
form of net presentation in the statement of financial position is prohibited. This is
because the entity would remain liable for the whole cost if the third party failed to pay
for any reason, for example as a result of the third party’s insolvency. In such situations,
the provision should be made gross and any reimbursement should be treated as a
separate asset (but only when it is virtually certain that the reimbursement will be
received if the entity settles the obligation). [IAS 37.56].
If the entity has no liability in the event that the third party cannot pay, then these costs
are excluded from the estimate of the provision altogether because, by its very nature,
there is no liability. [IAS 37.57].
In contrast, where an entity is assessing an onerous contract, it is common for entities
to apply what looks like a net approach. However, because an onerous contract
provision relates to the excess of the unavoidable costs over the expected economic
benefits, [IAS 37.68], there is no corresponding asset to be recognised. This is discussed
further at 6.2 below.
4.7
Joint and several liability
It is interesting to contrast the approach of IAS 37 to reimbursements with the case where
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br /> an entity is jointly and severally liable for an obligation. Joint and several liability arises
when a number of entities are liable for a single obligation (for example, to damages), both
individually and collectively. The holder of the obligation in these circumstances can
collect the entire amount from any single member of the group or from any and all of the
Provisions, contingent liabilities and contingent assets 1899
members in various amounts until the liability is settled in full. Even when the members
have an agreement between themselves as to how the total obligation should be divided,
each member remains liable to make good any deficiency on the part of the others. This
situation is different from proportionate liability, where individual members of a group
might be required to bear a percentage of the total liability, but without any obligation to
make good any shortfall by another member. Joint and several liability can be established
in a contract, by a court judgement or under legislation.
An entity that is jointly and severally liable recognises only its own share of the obligation,
based on the amount it is probable that the entity will pay. The remainder that is expected
to be met by other parties is treated only as a contingent liability. [IAS 37.29, 58].
The fact that the other third parties in this situation have a direct (albeit shared) obligation
for the past event itself, rather than only a contractual relationship with the entity, is
enough of a difference in circumstances to allow a form of net determination of the
amount to recognise. Arguably, the economic position is no different, because the entity
is exposed to further loss in the event that the third parties are unable or unwilling to pay.
However, IAS 37 does not treat joint and several liability in the same way as
reimbursement, which would have required a liability to be set up for the whole amount
with a corresponding asset recognised for the amount expected to be met by other parties.
4.8
Provisions are not reduced for gains on disposal of related assets
IAS 37 states that gains from the expected disposal of assets should not be taken into account
in measuring a provision, even if the expected disposal is closely linked to the event giving
rise to the provision. Such gains should be recognised at the time specified by the Standard
dealing with the assets concerned. [IAS 37.51-52]. This is likely to be of particular relevance in
relation to restructuring provisions (see 6.1.4 below). However, it may also apply in other
situations. Extract 27.4 at 6.3 below illustrates an example of a company excluding gains
from the expected disposal of assets in determining its provision for decommissioning costs.
4.9
Changes and uses of provisions
After recognition, a provision will be re-estimated, used and released over the period up
to the eventual determination of a settlement amount for the obligation. IAS 37 requires
that provisions should be reviewed at the end of each reporting period and adjusted to
reflect the current best estimate. If it is no longer probable that an outflow of resources
embodying economic benefits will be required to settle the obligation, the provision
should be reversed. [IAS 37.59]. Where discounting is applied, the carrying amount of a
provision increases in each period to reflect the passage of time. This increase is
recognised as a borrowing cost. [IAS 37.60]. As discussed at 4.3.5 above, the periodic
unwinding of the discount is recognised as a finance cost in the income statement, and it
is not a borrowing cost capable of being capitalised under IAS 23. [IFRIC 1.8].
The standard does not allow provisions to be redesignated or otherwise used for
expenditures for which the provision was not originally recognised. [IAS 37.61]. In such
circumstances, a new provision is created and the amount no longer needed is reversed,
as to do otherwise would conceal the impact of two different events. [IAS 37.62]. This
means that the questionable practice of charging costs against a provision that was set
up for a different purpose is specifically prohibited.
1900 Chapter 27
4.10 Changes in contingent liabilities recognised in a business
combination
In a business combination, the usual requirements of IAS 37 do not apply and the
acquirer recognises a liability at the acquisition date for those contingent liabilities of
the acquiree that represent a present obligation arising as a result of a past event and in
respect of which the fair value can be measured reliably. [IFRS 3.23]. After initial
recognition, and until the liability is settled, cancelled or expires, the acquirer measures
the contingent liability recognised in a business combination at the higher of: [IFRS 3.56]
(a) the amount that would be recognised in accordance with IAS 37; and
(b) the amount initially recognised less, if appropriate, the cumulative amount of
income recognised in accordance with the principles of IFRS 15. [IFRS 3.56].
This requirement does not apply to contracts accounted for in accordance with IFRS 9.
See Chapter 9 at 5.6.1.B.
This requirement prevents the immediate release to post acquisition profit of any
contingency recognised in a business combination.
5
CASES IN WHICH NO PROVISION SHOULD BE
RECOGNISED
IAS 37 sets out three particular cases in which the recognition of a provision is
prohibited. They are: future operating losses, repairs and maintenance of owned assets
and staff training costs. The Interpretations Committee has also considered repeated
requests relating to obligations arising on entities operating in a rate-regulated
environment. The Interpretations Committee concluded that there is no justification for
the recognition of a special regulatory liability, although the issue of IFRS 14 –
Regulatory Deferral Accounts – in January 2014 provides some relief for first-time
adopters of IFRS who have recognised regulatory deferral account balances under their
previous GAAP (see 5.4 below). The common theme in these cases is that the potential
obligation does not exist independently of an entity’s future actions. In other words, the
entity is able to change the future conduct of its business in a way that avoids the future
expenditure. Only those obligations that exist independently of an entity’s future actions
are recognised as provisions. [IAS 37.19]. This principle is also relevant to determining the
timing of recognition of a provision, whereby no liability is recognised until the
obligation cannot otherwise be avoided by the entity. Examples include those arising
from participation in a particular market under IFRIC 6 (see 6.7 below) and an obligation
for levies imposed by government under IFRIC 21 (see 6.8 below).
5.1
Future operating losses
IAS 37 explicitly states that ‘provisions shall not be recognised for future operating
losses’. [IAS 37.63]. This is because such losses do not meet the definition of a liability and
the general recognition criteria of the standard. [IAS 37.64]. In particular there is no
present obligation as a result of a past event. Such costs should be left to be recognised
as they occur in the future in the same way as future profits.
Provisions, contingent
liabilities and contingent assets 1901
However, it would be wrong to assume that this requirement has effectively prevented
the effect of future operating losses from being anticipated, because they are sometimes
recognised as a result of requirements in another standard, either in the measurement of
an asset of the entity or to prevent inappropriate recognition of revenue. For example:
• under IAS 2 – Inventories – inventories are written down to the extent that they
will not be recovered from future revenues, rather than leaving the non-recovery
to show up as future operating losses (see Chapter 22 at 3.3); and
• under IAS 36 impairment is assessed on the basis of the present value of future
operating cash flows, meaning that the effect of not only future operating losses
but also sub-standard operating profits will be recognised (see Chapter 20). IAS 37
specifically makes reference to the fact that an expectation of future operating
losses may be an indication that certain assets are impaired. [IAS 37.65].
This is therefore a rather more complex issue than IAS 37 acknowledges. Indeed, IAS 37
itself has to navigate closely the dividing line between the general prohibition of the
recognition of future losses and the recognition of contractual or constructive
obligations that are expected to give rise to losses in future periods.
5.2
Repairs and maintenance of owned assets
Repairs and maintenance provisions in respect of owned assets are generally prohibited
under IAS 37. Under the standard, the following principles apply:
(a) provisions are recognised only for obligations existing independently of the entity’s
future actions (i.e. the future conduct of its business) and in cases where an entity
can avoid future expenditure by its future actions, for example by changing its
method of operation, it has no present obligation; [IAS 37.19]
(b) financial statements deal with an entity’s position at the end of the reporting period
and not its possible position in the future. Therefore, no provision is recognised
for costs that need to be incurred to operate in the future; [IAS 37.18] and
(c) for an event to be an obligating event, the entity can have no realistic alternative
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 374
