I.

Provisions under PAS 37

 Scope
 This Standard shall be applied by all entities in accounting for provisions, contingent liabilities
and contingent assets, except:
 Those resulting from executory contracts, except where the contract is onerous; and
 Those covered by another Standard.

 Provisions and other liabilities

 Provisions can be distinguished from other liabilities such as trade payables and accruals because
there is uncertainty about the timing or amount of the future expenditure required in settlement.
 Accruals are often reported as part of trade and other payables, whereas provisions are reported
separately.

 Provisions and contingent liabilities

 In a general sense, all provisions are contingent because they are uncertain in timing or amount.
 However, the term ‘contingent’ is used for liabilities and assets that are not recognized because
their 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 entity.

 Recognition
 A provision shall be recognized when:
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.
 If these conditions are not met, no provision shall be recognized.

 Present obligation
 In rare cases it is not clear whether there is a present obligation. In these cases, a past event is
deemed to give rise to a present obligation if, taking account of all available evidence, it is more
likely than not that a present obligation exists at the end of the reporting period.
 The evidence considered includes any additional evidence provided by events after the reporting
period. On the basis of such evidence:
a. Where it is more likely than not that a present obligation exists at the end of the reporting
period, the entity recognizes a provision (if the recognition criteria are met); and
b. Where it is more likely that no present obligation exists at the end of the reporting period, the
entity discloses a contingent liability, unless the possibility of an outflow of resources
embodying economic benefits is remote.

 Past event
 A past event that leads to a present obligation is called an obligating event. This is the case only:
a. Where the settlement of the obligation can be enforced by law; or
b. In the case of a constructive obligation, where the event (which may be an action of the entity)
creates valid expectations in other parties that the entity will discharge the obligation.
 No provision is recognized for costs that need to be incurred to operate in the future.
 It is only those obligations arising from past events existing independently of an entity’s future
actions (i.e. the future conduct of its business) that are recognized as provisions.
 An obligation always involves another party to whom the obligation is owed. It is not necessary,
however, to know the identity of the party to whom the obligation is owed.
 An event that does not give rise to an obligation immediately may do so at a later date, because of
changes in the law or because an act by the entity gives rise to a constructive obligation.
  Where details of a proposed new law have yet to be finalized, an obligation arises only when the
legislation is virtually certain to be enacted as drafted. Such an obligation is treated as a legal
obligation.

 Probable outflow of resources embodying economic benefits

 For a liability to qualify for recognition there must be not only a present obligation but also the
probability of an outflow of resources embodying economic benefits to settle that obligation.
 An outflow of resources or other event is regarded as probable if the probability that the event
will occur is greater than the probability that it will not.
 Where it is not probable that a present obligation exists, an entity discloses a contingent liability,
unless the possibility of an outflow of resources embodying economic benefits is remote.

 Reliable estimate of the obligation

 The use of estimates is an essential part of the preparation of financial statements and does not
undermine their reliability.
 An entity will be able to determine a range of possible outcomes and can therefore make an
estimate of the obligation that is sufficiently reliable to use in recognizing a provision.
 In the extremely rare case where no reliable estimate can be made, a liability exists that cannot
be recognized. That liability is disclosed as a contingent liability.

 Contingent liabilities
 An entity shall not recognize a contingent liability.
 A contingent liability is disclosed, unless the possibility of an outflow of resources embodying
economic benefits is remote.

 Contingent assets
 An entity shall not recognize a contingent asset.
 Contingent assets usually arise from unplanned or other unexpected events that give rise to the
possibility of an inflow of economic benefits to the entity.
 When the realization of income is virtually certain, then the related asset is not a contingent asset
and its recognition is appropriate.
 A contingent asset is disclosed where an inflow of economic benefits is probable.

 Measurement
 Best estimate
 The best estimate of the expenditure required to settle the present obligation is the amount
that an entity would rationally pay to settle the obligation at the end of the reporting period
or to transfer it to a third party at that time.
 Expected value
 Where the provision being measured involves a large population of items, the obligation is
estimated by weighting all possible outcomes by their associated probabilities.
 Midpoint
 Where there is a continuous range of possible outcomes, and each point in that range is as
likely as any other, the mid-point of the range is used.
 The provision is measured before tax.

 Risks and uncertainties

 The risks and uncertainties that inevitably surround many events and circumstances shall be
taken into account in reaching the best estimate of a provision.
 Risk describes variability of outcome. A risk adjustment may increase the amount at which a
liability is measured.
 Disclosure of the uncertainties surrounding the amount of the expenditure shall be made.
 Present value
 Where the effect of the time value of money is material, the amount of a provision shall be the
present value of the expenditures expected to be required to settle the obligation.
 The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s) current market
assessments of the time value of money and the risks specific to the liability. The discount rate(s)
shall not reflect risks for which future cash flow estimates have been adjusted.

 Future events
 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.

 Expected disposal of assets

 Gains on the expected disposal of assets are not taken into account in measuring a provision, even
if the expected disposal is closely linked to the event giving rise to the provision.

 Reimbursements
 Where some or all of the expenditure required to settle a provision is expected to be reimbursed
by another party, the reimbursement shall be recognized when, and only when, it is virtually
certain that reimbursement will be received if the entity settles the obligation.
 The reimbursement shall be treated as a separate asset. The amount recognized for the
reimbursement shall not exceed the amount of the provision.
 In the statement of comprehensive income, the expense relating to a provision may be presented
net of the amount recognized for a reimbursement.

 Changes in provisions
 Provisions shall 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 shall be reversed.
 Where discounting is used, the carrying amount of a provision increases in each period to reflect
the passage of time. This increase is recognized as borrowing cost.

 Use of provisions, future operating losses, and onerous contracts

 A provision shall be used only for expenditures for which the provision was originally recognized.
 Provisions shall not be recognized for future operating losses.
 If an entity has a contract that is onerous, the present obligation under the contract shall be
recognized and measured as a provision. The unavoidable costs under a contract reflect the least
net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any
compensation or penalties arising from failure to fulfil it.

 Restructuring
 A provision for restructuring costs is recognized only when the general recognition criteria for
provisions are met.
 The following are examples of events that may fall under the definition of restructuring:
a. 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 reorganizations that have a material effect on the nature and focus of the
entity’s operations.
 A constructive obligation to restructure arises only when an entity:
 a. Has a detailed formal plan for the restructuring identifying at least:
i. The business or part of a business concerned
ii. The principal locations affected
iii. The location, function, and approximate number of employees who will be compensated for
terminating their services
iv. The expenditures that will be undertaken
v. When the plan will be implemented
b. Has raised a valid expectation in those affected that it will carry out the restructuring by
starting to implement that plan or announcing its main features to those affected by it.
 A restructuring provision does not include such costs as: retraining or relocating continuing staff,
marketing and investment in new systems and distribution networks.

 Examples of provisions
Circumstance Recognize a provision?

Restructuring by sale of an Only when the entity is committed to a sale, i.e. there is a binding sale agreement
operation [IAS 37.78]

Restructuring by closure or Only when a detailed form plan is in place and the entity has started to implement
reorganization the plan, or announced its main features to those affected. A Board decision is
insufficient [IAS 37.72, Appendix C, Examples 5A & 5B]

Warranty When an obligating event occurs (sale of product with a warranty and probable
warranty claims will be made) [Appendix C, Example 1]

Land contamination
A provision is recognized as contamination occurs for any legal obligations of
clean up, or for constructive obligations if the company's published policy is to
clean up even if there is no legal requirement to do so (past event is the contam-
ination and public expectation created by the company's policy) [Appendix C,
Examples 2B]

Customer refunds Recognize a provision if the entity's established policy is to give refunds (past
event is the sale of the product together with the customer's expectation, at time
of purchase, that a refund would be available) [Appendix C, Example 4]

Offshore oil rig must be Recognize a provision for removal costs arising from the construction of the oil
removed and sea bed rig as it is constructed, and add to the cost of the asset. Obligations arising from
restored the production of oil are recognized as the production occurs [Appendix C,
Example 3]

Abandoned leasehold, four A provision is recognized for the unavoidable lease payments [Appendix C,
years to run, no re-letting Example 8]
possible

CPA firm must staff training No provision is recognized (there is no obligation to provide the training,
for recent changes in tax law recognize a liability if and when the retraining occurs) [Appendix C, Example 7]

Major overhaul or repairs No provision is recognized (no obligation) [Appendix C, Example 11]

Onerous (loss-making) Recognize a provision [IAS 37.66]

contract

Future operating losses No provision is recognized (no liability) [IAS 37.63]

 II. Provisions under IFRIC 1

 Decommissioning liability
 Changes in the measurement of an existing decommissioning, restoration and similar liability that
result from changes in the estimated timing or amount of the outflow of resources embodying
economic benefits required to settle the obligation, or a change in the discount rate, shall be
accounted for as follows:

 If the related asset is measured using the cost model:

a. Changes in the liability shall be added to (increase in liability), or deducted from (decrease
in liability), the cost of the related asset in the current period.
b. The amount deducted from the cost of the asset shall not exceed its carrying amount. If a
decrease in the liability exceeds the carrying amount of the asset, the excess shall be
recognized immediately in profit or loss.
c. If the adjustment results in an addition to the cost of an asset, the entity shall consider
whether this is an indication that the new carrying amount of the asset may not be fully
recoverable. If it is such an indication, the entity shall test the asset for impairment.

 If the related asset is measured using the revaluation model

a. Changes in the liability alter the revaluation surplus or deficit previously recognized on
that asset, so that:
o a decrease in the liability shall be recognized in other comprehensive income and
increase the revaluation surplus within equity, except that it shall be recognized in
profit or loss to the extent that it reverses a revaluation deficit on the asset that was
previously recognized in profit or loss;
o an increase in the liability shall be recognized in profit or loss, except that it shall be
recognized in other comprehensive income and reduce the revaluation surplus
within equity to the extent of any credit balance existing in the revaluation surplus in
respect of that asset.
b. In the event that a decrease in the liability exceeds the carrying amount that would have
been recognized had the asset been carried under the cost model, the excess shall be
recognized immediately in profit or loss.
c. A change in the liability is an indication that the asset may have to be revalued in order to
ensure that the carrying amount does not differ materially from that which would be
determined using fair value at the end of the reporting period. Any such revaluation shall
be taken into account in determining the amounts to be recognized in profit or loss or in
other comprehensive income under (a).
d. The change in the revaluation surplus arising from a change in the liability shall be
separately identified and disclosed as such.