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Accounting and Financial Reporting Provisions, Contingent liabilities and assets IAS 37

Marcov Xenia Poghosyan Armine

International Accounting Standard 37 Provisions, Contingent Liabilities and Contingent Assets

IAS 37 Provisions, Contingent Liabilities and Contingent Assets was issued by the International Accounting Standards Committee in September 1998. It replaced parts of IAS 10 Contingencies and Events Occurring After the Balance Sheet Date (issued in 1978 and reformatted in 1994) that dealt with contingencies.

The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount.

Specific applications
The Standard explains how the general recognition and measurement requirements for provisions should be applied in three specific cases: - future operating losses - onerous contracts - restructurings.

A provision is a liability of uncertain timing or amount. A provision shall be recognized if the following criteria are fulfilled: an entity has a present obligation as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; a reliable estimate can be made of the amount of the obligation.

1st case future operating losses

Provisions should not be recognized for future operating losses. An expectation of future operating losses is an indication that certain assets of the operation may be impaired. In this case, an entity tests these assets for impairment under IAS 36 Impairment of Assets.

2nd case onerous contracts

If an entity has a contract that is onerous, the present obligation under the contract should be recognized and measured as a provision. An onerous contract is one in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

3rd case - restructuring

The Standard 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.

Restructuring provision
A restructuring provision should include only the direct expenditures arising from the restructuring, which are those that are both: (a) necessarily entailed by the restructuring; and (b) not associated with the ongoing activities of the entity. Thus, a restructuring provision does not include such costs as: retraining or relocating continuing staff; marketing; or investment in new systems and distribution networks.

Contingent liabilities
Contingent liability - a potential liability that depends on a future event occurring or not occurring. (e.g. a lawsuit)
If a company is sued by a former employee for $500,000 for age discrimination, the company has a contingent liability. If the company is found guilty, it will have a liability. However, if the company is not found guilty, the company will not have an actual liability.

Contingent asset
A contingent asset is a potential asset associated with a contingent gain.
An example of a contingent gain and contingent asset might be a lawsuit filed by Company A against Company B for infringement of Company A's patent. If it is probable that Company A will win the lawsuit and receive an estimated amount of money, it has a contingent asset and a contingent gain. However, it will not report the asset and gain until the lawsuit is settled.

Relationship between provisions and contingent liabilities and assets

In a general sense, all provisions are contingent because they are uncertain in timing or amount. However, within this Standard 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. In addition, the term contingent liability is used for liabilities that do not meet the recognition criteria.

The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature are more uncertain than most other items in the statement of financial position.

Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. The name for this statistical method of estimation is expected value.

Changes in provisions
Provisions shall be reviewed at the end of each reporting period. 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.

KGHM Polska Mied S.A. Annual financial statements prepared in accordance with IFRS as adopted by the European Union for the period from 1 January 2011 to 31 December 2011 (amounts in tables in thousand PLN, unless otherwise stated)

3.4 Provisions
1. Provisions for future employee benefits retirement or disability benefits, jubilee bonuses, post-mortem benefits and postemployment coal equivalent payments are estimated using actuarial methods. A change in the financial factors being the basis for estimation, i.e. - an increase in the discount rate by 1% would cause a decrease in the provision by PLN 121 688 thousand, - a decrease in the discount rate by 1% would cause an increase in the provision by PLN 167 693 thousand, - an increase in the coal price and salary increase rates by 1% would cause an increase in the provision by PLN 177 518 thousand, - a decrease in the coal price and salary increase rates by 1% would cause a decrease in the provision by PLN 132 131 thousand.

3.4 Provisions
2. Provisions for decommissioning costs of mines and other facilities
These provisions represent the discounted to present value estimated future decommissioning costs of mines and other facilities. Revaluation of this provision at the end of the reporting period is affected by the following indicators: a) the index of changes in prices in the construction-assembly sector published by the Central Statistical Office (GUS), b) the real discount rate calculated based on the profitability of treasury bonds with maturities nearest to the planned financial outflow (nominal discount rate) and the forecast rate of inflation.nd other facilities.

3.4 Provisions
A 1% increase in the real discount rate (assumed in the reporting period at the level of 5.8%) used by the Management Board to estimate the amount of the provision for decommissioning costs of mines and other facilities would cause a decrease in the carrying amount of the provision by PLN 115 966 thousand. However, a 1% decrease in the real discount rate would cause an increase in the carrying amount of the provision by PLN 152 987 thousand.