to settling the obligation created by the event. [IAS 37.17].
These principles are applied strictly in the case of an obligation to incur repairs and
maintenance costs in the future, even when this expenditure is substantial, distinct from
what may be regarded as routine maintenance and essential to the continuing operations
of the entity, such as a major refit or refurbishment of the asset. This is illustrated by
two examples in an appendix to the standard.
Example 27.12: Prohibition on maintenance provisions relating to owned assets
Scenario 1: Re-lining costs of a furnace
An entity operates a furnace, the lining of which needs to be replaced every five years for technical reasons.
At the end of the reporting period, the lining has been in use for three years. In these circumstances, a
provision for the cost of replacing the lining is not recognised because, at the end of the reporting period, no
obligation to replace the lining exists independently of the entity’s future actions. Even the intention to incur
the expenditure depends upon the entity deciding to continue operating the furnace or to replace the lining.
Instead of a provision being recognised, the initial cost of the lining is treated as a significant part of the
furnace asset and depreciated over a period of five years. [IAS 16.43]. The re-lining costs are then capitalised
when incurred and depreciated over the next five years. [IAS 37 IE Example 11A].
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Scenario 2: Overhaul costs of an aircraft
An airline is required by law to overhaul its aircraft once every three years. Even with the legal requirement to perform the overhaul, there is no obligating event until the three year period has elapsed. As with Scenario 1, no obligation
exists independently of the entity’s future actions. The entity could avoid the cost of the overhaul by selling the aircraft before the three year period has elapsed. Instead of a provision being recognised, the overhaul cost is identified as a
separate part of the aircraft asset under IAS 16 and is depreciated over three years. [IAS 37 IE Example 11B].
Entities might try to argue that a repairs and maintenance provision should be recognised
on the basis that there is a clear intention to incur the expenditure at the appointed time
and that this means it is more likely than not, as at the end of the reporting period, that an
outflow of resources will occur. However, the application of the three principles noted
above, particularly that an entity should not provide for future operating costs, make an
entity’s intentions irrelevant. In the example above, recognition was not allowed because
the entity could do all manner of things to avoid the obligation, including selling the asset,
however unlikely that might be in the context of the entity’s business or in terms of the
relative cost of replacement as compared to repair. The existence of a legal requirement,
probably resulting in the aircraft being grounded, was still not enough. This detachment
from intention or even commercial reality, regarded by some as extreme, is most recently
exhibited in the Interpretations Committee’s approach to the recognition of levies
imposed by government under IFRIC 21 (see 6.8 below).
The effect of the prohibition on setting up provisions for repairs obviously has an impact
on presentation in the statement of financial position. It may not always, however, have
as much impact on the statement of comprehensive income. This is because it is stated
in the examples that depreciation would be adjusted to take account of the repairs. For
example, in the case of the furnace lining, the lining should be depreciated over five
years in advance of its expected repair. Similarly, in the case of the aircraft overhaul,
the example in the standard states that an amount equivalent to the expected
maintenance costs is depreciated over three years. The result of this is that the
depreciation charge recognised in profit or loss over the life of the component of the
asset requiring regular repair may be equivalent to that which would previously have
arisen from the combination of depreciation and a provision for repair. This is the way
IAS 16 requires entities to account for significant parts of an item of property, plant and
equipment which have different useful lives (see Chapter 18 at 5.1). [IAS 16.44].
5.3
Staff training costs
In the normal course of business it is unlikely that provisions for staff training costs would
be permissible, because it would normally contravene the general prohibition in the
standard on the recognition of provisions for future operating costs. [IAS 37.18]. In the
context of a restructuring, IAS 37 identifies staff retraining as an ineligible cost because it
relates to the future conduct of the business. [IAS 37.81]. Example 27.2 at 3.1.1 above
reproduces an example in the standard where the government introduces changes to the
income tax system, such that an entity in the financial services sector needs to retrain a
large proportion of its administrative and sales workforce in order to ensure continued
compliance with financial services regulation. The standard argues that there is no present
obligation until the actual training has taken place and so no provision should be
recognised. We also note that in many cases the need to incur training costs is not only
future operating expenditure but also fails the ‘existing independently of an entity’s future
Provisions, contingent liabilities and contingent assets 1903
actions’ criterion, [IAS 37.19], in that the cost could be avoided by the entity, for example, if
it withdrew from that market or hired new staff who were already appropriately qualified.
This example again illustrates how important it is to properly understand the nature of
any potential ‘constructive obligation’ or ‘obligating event’ and to determine separately
its financial effect in relation to past transactions and events on the one hand and in
relation to the future operation of the business on the other. Otherwise, it can be easy
to mistakenly argue that a provision is required, such as for training costs to ensure that
staff comply with new legal requirements, on the basis that the entity has a constructive
obligation to ensure staff are appropriately skilled to adequately meet the needs of its
customers. However, the obligation, constructive or not, declared or not, relates to the
entity’s future conduct, is a future cost of operation and is therefore ineligible for
recognition under the standard until the training takes place.
5.4 Rate-regulated
activities
In many countries, the provision of utilities (e.g. water, natural gas or electricity) to
consumers is regulated by the national government. Regulations differ between countries
but often regulators operate a cost-plus system under which a utility provider is allowed
to make a fixed return on investment. Under certain national GAAPs, an entity may
account for the effects of regulation by recognising a ‘regulatory asset’ that reflects the
increase in future prices approved by the regulator or a ‘regulatory liability’ that reflects a
requirement from the regulator to reduce tariffs or improve services so as to return the
benefit of earlier excess profits to customers. This issue has for a long time been a matter
of significant interest as enti
ties in those countries adopt IFRS, because the recognition of
these regulatory assets and liabilities is prohibited under IFRS. Just as the ability to charge
higher prices for goods services to be rendered in the future does not meet the definition
of an intangible asset in IAS 38 – Intangible Assets (see Chapter 17 at 11.1), the requirement
to charge a lower price for the delivery of goods and services in the future does not meet
the definition of a past obligating event, or a liability, in IAS 37.
A liability is defined in IAS 37 as ‘a present obligation of the entity arising from past
events, the settlement of which is expected to result in an outflow from the entity of
resources embodying economic benefits’. [IAS 37.10]. The return to customers of amounts
mandated by a regulator depends on future events including:
• future rendering of services;
• future volumes of output (generally consisting of utilities such as water or
electricity) consumed by users; and
• the continuation of regulation.
Similar considerations apply to actions that a regulator may require entities to complete
in the future, such as an obligation to invest in equipment to improve efficiency. Other
than decommissioning obligations (see 6.3 below), such items do not meet the definition
of a liability because there needs to be a present obligation at the end of the reporting
period before a liability can be recognised. Such a regulatory obligation that fails to
qualify for recognition under IAS 37 is illustrated in Extract 27.1 at 3.1.1 above.
Whilst the requirements of IAS 37 and the Conceptual Framework issued in 2010 are
clear in this respect, their perceived inflexibility in this regard has been identified as a
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significant barrier that prevents the entities affected by it from adopting IFRS as a
whole.10 In an effort to establish a way for certain liabilities and assets to achieve
recognition under very limited circumstances, the IASB issued an exposure draft in
July 2009 on rate-regulated activities. However, the IASB discontinued the project in
September 2011, on the basis that the complexities of the issue could not be resolved
quickly and cited resource constraints. However, it identified the following options
which were then presented in its 2011 agenda consultation document:11
• a disclosure only standard;
• an interim standard to ‘grandfather’ previous GAAP accounting practices with
some limited improvements;
• a medium-term project focused on the effects of rate-regulation; or
• addressing it as part of a comprehensive project on intangible assets.
In response to the feedback received, the IASB embarked on a two-tier approach. In
September 2012 the IASB added to its agenda a comprehensive research project on
rate-regulated activities and in December 2012 the IASB decided to develop an interim
Standard on the accounting for regulatory deferral accounts that would apply for first-
time adopters of IFRS until the completion of the comprehensive project.12 The interim
Standard, IFRS 14 was issued in January 2014 and became effective for annual periods
beginning on or after 1 January 2016, with early application permitted. [IFRS 14.C1]. The
Standard can be applied in only very limited circumstances.
A first-time adopter is permitted (but not required) to apply IFRS 14 in its first IFRS
financial statements if, and only if, it conducts rate-regulated activities (as defined in the
Standard) and recognised amounts that qualify as regulatory deferral account balances
in its financial statements prepared under its previous GAAP. [IFRS 14.5]. An entity shall
not change its accounting policies in order to start to recognise regulatory deferral
account balances. [IFRS 14.13].
Entities can apply IFRS 14 after first-time adoption if, and only if, they had elected to
apply the Standard in their first IFRS financial statements and had recognised regulatory
deferral account balances in those financial statements. [IFRS 14.6]. Therefore, the scope
for applying this standard does not extend to existing IFRS reporters; nor to first-time
adopters whose previous GAAP did not allow for the recognition of regulatory assets
and liabilities; nor even to first-time adopters whose previous GAAP allowed such
recognition but the entity chose not to do so.
The requirements of first-time adoption of IFRS are discussed further in Chapter 5.
As regards its comprehensive research project, in September 2014 the IASB issued the
discussion paper Reporting the Financial Effects of Rate Regulation. The discussion
paper focused on developing an overall definition of rate regulation (‘defined rate
regulation’) and was intended to obtain feedback on:
(a) the common features of rate regulation that create a combination of rights and
obligations that are distinguishable from those activities that are not rate-regulated
and would support the recognition of an asset or liability in the statement of
financial position;
Provisions, contingent liabilities and contingent assets 1905
(b) whether the description of the defined rate regulation encompassed those features
of regulation that have the most significant effect on the amount, timing and
certainty or revenue, profit and cash flows of rate-regulated entities, for which
specific accounting requirements should be developed; and
(c) what information about the financial effects of rate regulation is most relevant to
users of financial statements in making investment and lending decisions.
The discussion paper did not include specific accounting proposals. Instead, it explored
several possible approaches that the IASB might consider when deciding how best to
report the financial effects of defined rate regulation and sought feedback on the
advantages and disadvantages of those possible approaches. In line with feedback from
the discussion paper and subsequent outreach activities, the IASB has begun developing
a model to lead to the recognition of certain regulatory assets and regulatory liabilities.
Discussions of the proposed model have continued during 2018, and a further discussion
paper or exposure draft is expected in the second half of 2019.13
6
SPECIFIC EXAMPLES OF PROVISIONS AND
CONTINGENCIES
IAS 37 expands on its general recognition and measurement requirements by including
more specific requirements for particular situations, i.e. future restructuring costs and
onerous contracts. This section discusses those situations, looks at other examples,
including those addressed in an appendix to the Standard and other areas where the
Interpretations Committee has considered how the principles of IAS 37 should be applied.
6.1 Restructuring
provisions
IAS 37 allows entities to recognise restructuring provisions, but it has specific rules on
the nature of obligations and the types of cost that are eligible for inclusion in such
provisions, as discussed below. These rules ensure that entities recognise only
obligations that exist independently of their future actions, [IAS 37.19], and that provisions
are not made for future operating costs and losses. [IAS 37.63].
6.1.1 Definition
IAS 37 defines a restructuring as �
�a programme that is planned and controlled by
management, and materially changes either:
(a) the scope of a business undertaken by an entity; or
(b) the manner in which that business is conducted’. [IAS 37.10].
This is said to include:
(a) the sale or termination of a line of business;
(b) the closure of business locations in a country or region or the relocation of business
activities from one country or region to another;
(c) changes in management structure, for example, eliminating a layer of management;
and
(d) fundamental reorganisations that have a material effect on the nature and focus of
the entity’s operations. [IAS 37.70].
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This definition is very wide and whilst it may be relatively straightforward to establish
whether an operation has been sold, closed or relocated, the determination of whether
an organisational change is fundamental, material or just part of a process of continuous
improvement is a subjective judgement. Whilst organisational change is a perennial
feature in most business sectors, entities could be tempted to classify all kinds of
operating costs as restructuring costs and thereby invite the user of the financial
statements to perceive them in a different light from the ‘normal’ costs of operating in a
dynamic business environment. Even though the requirements in IAS 37 prevent such
costs being recognised too early, the standard still leaves the question of classification
open to judgement. As such there can be a tension between the permitted recognition
of expected restructuring costs, subject to meeting the criteria set out at 6.1.2 below, and
the general prohibition in IAS 37 against provision for future operating losses, which is
discussed above at 5.1.
IAS 37 emphasises that when a restructuring meets the definition of a discontinued
operation under IFRS 5, additional disclosures may be required under that standard
(see Chapter 4 at 3). [IAS 37.9].
6.1.2
Recognition of a restructuring provision
IAS 37 requires that restructuring costs are recognised only when the general
recognition criteria in the standard are met, i.e. there is a present obligation (legal or
constructive) as a result of a past event, in respect of which a reliable estimate can be
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 375
