International Accounting

Standard 37 (IAS 37),

Provisions, Contingent Liabilities
and Contingent Assets
By BRIAN FRIEDRICH, MEd, CGA, FCCA(UK), CertIFR and LAURA FRIEDRICH,
MSc, CGA, FCCA(UK), CertIFR
Updated By STEPHEN SPECTOR, MA, FCGA

This article is part of a series by the Friedrichs and Stephen Spector on the move to
International Financial Reporting Standards to be published on PD Net.
Snapshot
Overview of IAS 37
Differences from
Canadian GAAP

Snapshot
First released

September 1998

Subsequent amendments

2003, 2004, 2005, 2007, and 2008 (to

reflect changes in a variety of standards)

Effective date (IASB basis)

fiscal periods beginning on or after

July 1, 1999

Effective date (Canadian basis)

fiscal periods beginning on or after

January 1, 2011

Outstanding Exposure Drafts and

issues under consideration

ED of substantial revisions was released

June 30, 2005; no revised standard has
yet been released the IASB has been
unable to reach a final position regarding
the measurement requirements and the
removal of the probability recognition
criterion in the ED. A new Non-financial
Liabilities exposure draft is expected late in
2009

Overview of IAS 37
Objective
The objective of IAS 37 is to ensure that provisions, contingent liabilities, and
contingent assets are recognized based on appropriate criteria and measured using
appropriate bases. Furthermore, the standard aims to ensure that the notes to financial
CGA-Canada 2009

statements provide sufficient information so that users can understand the nature, timing,
and amount of any provisions, contingent liabilities, and contingent assets. The key
underlying principle is that a provision should be recognized only when a liability exists;
accordingly, planned future expenditures are not recognized as provisions or
contingencies, even if the board of directors has authorized them.

Scope
IAS 37 does not deal with provisions, contingent liabilities, and contingent assets that
fall into the following two broad categories (1 to 5):
1. Items arising from non-onerous executory contracts
An executory contract is one where neither party to the contract has performed any of
their obligations, or where both parties have performed a portion of their obligations to an
equal extent. IAS 37 applies to an executory contract only if the contract is onerous,
meaning that the unavoidable costs of fulfilling the contract or exiting from it exceed the
economic benefits expected to be received under it.
2. Items covered by another standard
Items that are specifically addressed in another standard are scoped out of IAS 37. For
example, some types of provisions are addressed in IAS 11 Construction Contracts,
IAS 12 Income Taxes, IAS 17 Leases, and IAS 19 Employee Benefits. In addition, the
standard does not apply to financial instruments (including guarantees) that are covered
under IAS 39 Financial Instruments: Recognition and Measurement. Finally, IAS 37
does not cover provisions, contingent liabilities, and contingent assets arising from
insurance contracts (IFRS 4 Insurance contracts covers them), but it does deal
provisions, contingent liabilities, and contingent assets of the insurer (unless these
elements arise from contractual obligations and rights under insurance contracts within
the scope of IFRS 4).

Highlights of the standard

Definitions
Paragraph 10 provides definitions for the following key terms (among others):
A constructive obligation is 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.
A contingent asset is a possible asset that arises from past events and whose

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.
A contingent liability is:

(a) a possible obligation that arises from past events and whose 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; or
(b) a present obligation that arises from past events but is not recognized because:
(i) it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability.

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 2

 An obligating event is an event that creates a legal or constructive obligation that

results in an entity having no realistic alternative to settling that obligation.

A provision is a liability of uncertain timing or amount.

Provisions are distinguished from accruals because, although both may require estimates,
there is much less uncertainty with accruals than with provisions.
Recognition of provisions and contingencies
Contingent assets (31 to 35)
IAS 37 prohibits the recognition of contingent assets, based on the perspective that including
a contingent asset on the balance sheet might result in the recognition of income that is never
realized. However, if an inflow of economic benefits is probable (that is, more likely than
not1), the contingent asset should be disclosed. Note that if an inflow of economic benefits is
virtually certain, then the related asset is not contingent on an event occurring and,
therefore, it should be recognized in the financial statements.
Contingent liabilities (27 to 30)
Contingent liabilities are also not recognized in the financial statements, but they must be
disclosed unless the possibility of an outflow of economic resources is remote. Contingent
liabilities should be continually monitored, and if the outflow of resources becomes probable,
they should be recognized as provisions.
Provisions
A provision is recognized in the financial statements when (14)
a) an entity has a present obligation as a result of a past event (the obligating event);
b) it is probable that an outflow of economic resources will be required to settle the
obligation; and
c) the amount of the obligation can be reliably estimated.
Note from the definition of a contingent liability (in paragraph 10, above) that if an item
meets the first criterion for recognition as a provision, but does not meet either the second or
third criteria, it is treated as a contingent liability.
When a provision is recognized, the debit side of the entry is not always an expense; IAS 37
recognizes that in some cases the amount may be debited to an asset account (this would be
the case, for example, when recognizing an obligation for environmental cleanup on a new
mine site).
In determining whether a provision should be recognized, the present obligation does not
need to be a legal obligation; constructive obligations also give rise to provisions if the other
two criteria are met. In rare cases, such as some lawsuits, it may not be clear whether a
present obligation exists. Accordingly, a provision is recognized if the outflow of economic
benefits is more likely than not. If this test is not met, the item would be treated as a
contingent liability, and would be disclosed unless remote.
IAS 37 clearly states that no provision is recognized for future operating losses or for costs
that need to be incurred to operate in the future. Financial statements represent the financial
position of the company at the end of its reporting period and not its possible position in the
future. IAS 37 provides the following example to illustrate this point:

The interpretation of probable in this standard as more likely than not does not necessarily
apply in other standards.
International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 3

[A]n entity recognizes a provision for the decommissioning costs of an oil

installation or a nuclear power station to the extent that the entity is obliged to
rectify damage already caused. In contrast, because of commercial pressures or legal
requirements, an entity may intend or need to carry out expenditure to operate in a
particular way in the future (for example, by fitting smoke filters in a certain type of
factory). Because the entity can avoid the future expenditure by its future actions, for
example by changing its method of operation, it has no present obligation for that
future expenditure and no provision is recognized. (19)
With respect to obligations under contracts, if an entity has a contract that is onerous, the
present obligation is recognized as a provision. However, before a separate provision for an
onerous contract is established, an entity first must recognize any impairment losses that have
occurred on assets that are dedicated to that contract, in accordance with IAS 36 (66 to 69).
Restructuring
IAS 37 gives specific guidance as to provisions for restructuring. A restructuring is
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. (10)
This would include, for example, the sale or termination of a business line, the relocation or
closure of a business location, a change in management structure, or a reorganization that
materially impacts the nature and focus of operations. With these types of events, the difficulty
is in determining when a present obligation exists. For the sale of a business line, a provision
would be recognized once there is a binding sale agreement (78). In the case of a closure or
reorganization, however, the obligation arising from the event is more likely to be constructive,
rather than legal. A constructive obligation to restructure arises only when an entity has a
detailed formal plan for restructuring, and has raised a valid expectation in those affected that
it will carry out the restructuring. A valid expectation would be raised by either starting to
implement the plan, or by announcing the plans main features to those affected by it (72).
Whether arising from a legal or a constructive obligation, a restructuring provision should
include only the direct expenditures that result from the restructuring, not costs that are
associated with ongoing activities of the enterprise. Consequently, expenditures for marketing
or for relocating and retraining continuing staff would not be included in a restructuring
provision (80 to 81).
Measurement of a provision
The amount recognized as a provision is the best estimate of the amount required to settle the
obligation at the end of the reporting period in other words, the amount that the entity
would rationally pay to settle the obligation or to transfer it to a third party at that time (36
and 37). Determining the best estimate may involve expected value calculations, where
possible outcomes are weighted by their likely probabilities. This technique is particularly
useful where the provision being measured involves a large population of items (such as
warranties). For an individual obligation (such as the settlement of a lawsuit or environmental
cleanup), the best estimate of the liability may be the single most likely outcome, adjusted as
appropriate to consider risk and uncertainty.
Provisions are measured on a pre-tax basis, taking into account the time value of money, if
material. The discount rates used should be pre-tax rates that reflect the current market
assessment of the risks specific to the liability. The discount rate(s) should not, however,
reflect risks for which future cash-flow estimates have already been adjusted (45 to 47).

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 4

Future events that may affect the amount required to settle the present obligation (for
example, expected changes in technology that would reduce cleanup costs) should be
reflected in the amount of a provision only if there is sufficient objective evidence that they
will occur. The effect of changes in legislation should be reflected only if the legislation is
virtually certain to be enacted (48 to 50). Gains on the expected disposal of assets are not
taken into account when estimating provisions; instead, the entity recognizes any gains on the
expected disposal of assets as specified by the standard dealing with the assets concerned (51).
If all or part of the amount required to settle a provision is expected to be reimbursed by a
third party, the reimbursement should be recognized only when it is virtually certain that if the
enterprise settles the obligation, the reimbursement will be received. The amount recognized
should not exceed the amount of the provision. The reimbursement should be treated as a
separate asset, but in the statement of comprehensive income, the related expense may be
presented net of the amount recognized as a reimbursement (53 to 58).
Provisions should be reviewed at the end of each reporting period and adjusted to reflect the
current best estimate. The provision is reversed if it is no longer probable that an outflow of
economic resources will be required to settle the obligation (59).
The challenge associated with measurements is dealing with risks and uncertainties.
Paragraph 42 stipulates that the risks and uncertainties surrounding the events and
circumstances related to the provision need to be taken into account when reaching the best
estimate of the provision. The danger is that in deriving the best estimate, the adjustments for
risk and uncertainty can double up with consequent overstatement of a provision.
Presentation and disclosure
Provisions
Disclosure requirements under IAS 37 include reconciliations for each class of provision,
which include (84)
opening carrying amount
additions during the period, including increases to existing provisions
amounts charged against provisions during the period
unused amounts reversed during the period
unwinding of the discount (that is, the increase during the period in the discounted amount

arising from the passage of time and the effect of any change in the discount rate)
closing carrying amount.

Comparative information is not required for these reconciliations.

In addition, for each class of provision, the entity is required to disclose (85)
a brief description of the nature of the obligation and the expected timing of any resulting

economic outflows
an indication of the uncertainties surrounding the amount or timing of outflows
the major assumptions made concerning any future events that are reflected in the amount

of a provision because of their expected impact on the amount required to settle an obligation
information on any expected reimbursements

Contingent liabilities
Unless the possibility of any outflow in settlement is remote, the entity is required to provide
a brief description of the nature of each class of contingent liability and, where practicable,

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 5

a) an estimate of the financial effect, using the guidance on measurement discussed above
b) an indication of the uncertainties surrounding the amount or timing of outflows
c) the possibility of partial or full reimbursement from another party (86)
Contingent assets
If an inflow of economic benefits is probable, the entity should provide a brief description of
the nature of the contingent asset, and, where practicable, an estimate of its financial effect,
using the guidance on measurement discussed above.
General
If any of the required information on contingent assets or liabilities is not disclosed because it
is not practicable to do so, that fact must be stated.
IAS 37 recognizes that, in extremely rare cases, disclosure of some or all of the required
information would seriously prejudice the entitys position in a dispute with another party. In
such cases, the entity is not required to disclose the information, but it must disclose the
general nature of the dispute, the fact that the information has not been disclosed, and the
reasons for non-disclosure.
Appendix B of IAS 37 provides the following decision tree for addressing potential provisions
and contingencies. Note that this appendix accompanies, but is not part of, the standard.

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 6

Differences from Canadian GAAP

Accounting for provisions and contingencies follows the same fundamental principles under
both Canadian GAAP and IFRS, although IAS 37 is somewhat more conservative. In
addition, the terminology differs somewhat, as the CICA Handbook refers to both recognized
and unrecognized uncertain liabilities as contingent liabilities, rather than separating out
recognized amounts as provisions.
Specific differences are as follows:
Under Canadian GAAP, provisions are generally recognized based on either legal or

constructive obligations (which is the same as under IAS 37), although Canadian GAAP
does not specifically define a provision. However, the term contingent liability under
Canadian GAAP refers to both recognized and unrecognized uncertain obligations.
Canadian GAAP does not have separate terms to describe contingent liabilities that meet
the recognition criteria versus those that do not.
Liabilities for restructuring and asset retirement obligations are recognized under Canadian

GAAP only when there is a legal obligation (unlike IAS 37). Furthermore, under IFRSs,
International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 7

restructuring provisions arising from a business combination are recognized only when it is
an existing liability of the acquiree at the acquisition date.
Under Canadian GAAP, a provision is recognized if it is likely that a future event will

confirm that a liability has been incurred and the amount can be reasonably estimated.
IAS 37 requires provisions based on whether the outflows are more likely than not,
which may be interpreted to provide a lower threshold. Similarly, contingent assets are
disclosed under IAS 37 if they are more likely than not, whereas Canadian GAAP
requires gain contingencies to be likely before disclosure is made.
To estimate a provision based on a large population with a continuous range of equally

possible outcomes, IAS 37 states that the obligation is measured at the mid-point in the
range, whereas under Canadian GAAP it would be measured at the low end of the range.
Under Canadian GAAP, an obligation is generally measured at the single most likely

outcome, even if the possible outcomes are mostly higher or lower than that amount,
whereas under IAS 37 the single estimate would be adjusted.
IAS 37 requires that cash flows related to provisions be discounted if the effect is material.

Under Canadian GAAP, provisions are generally not discounted (unless specifically
required by a standard).
IAS 37 requires virtual certainty before a reimbursement is recognized; Canadian GAAP

requires only that recovery is likely.

Under Canadian GAAP, provisions based on onerous contracts are made only if required

by a specific standard.
Unlike Canadian GAAP, IAS 37 allows exemptions to some specific disclosure

requirements if the entitys position in a dispute would be seriously prejudiced.

Under IAS 37, if a contingent asset becomes virtually certain, then it is no longer

contingent and is recognized. Canadian GAAP does not allow for such recognition until the
asset is actually realized, with one exception: recoveries in respect of recognized losses are
recognised when receipt is likely.
Articles in this series will discuss:
IFRS 1 First-time Adoption of IFRS
IFRS 3 Business Combinations
IFRS 7 Financial Instruments: Disclosures
IAS 1 Presentation of Financial Statements
IAS 16 Property, Plant and Equipment
IAS 27 Consolidated and Separate Financial Statements
IAS 32 Financial Instruments: Presentation
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
For a more comprehensive introduction to the adoption of IFRSs, see the online course
IAS 36/IAS 37 on PD Net. You must be registered to access and purchase the course.
If you are not registered on PD Net, register now its fast, easy, and free.

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 8

Brian and Laura Friedrich are the principals of friedrich & friedrich corporation, an accounting
research, standards, and education firm. The firm provides policy, procedure, and governance
guidance; develops courses, examinations, and other assessments; and supports the development
of regional public accounting standards in Canada and internationally. Brian and Laura have
served as authors, curriculum developers, lecturers, exam developers, and markers for numerous
CGA and university courses in Canada, China, and the Caribbean. Their volunteer involvement
has earned them CGA-BCs inaugural Ambassador of Distinction Award (2004) and the J.M.
Macbeth Award for service at the chapter level (Brian in 2006 and Laura in 2007). Brian and
Laura are also Fellows of the Association of Chartered Certified Accountants.
Stephen Spector is a Lecturer currently teaching Financial and Managerial Accounting at
Simon Fraser University. He became a CGA in 1985 after obtaining his Master of Arts in
Economics from SFU in 1982. In 1997, CGA-BC presented him with the Harold Clarke
Award of Merit for recognition of his service to the By-Laws Committee for 1990-1996. In
1999, Stephen received the Fellow Certified General Accountant (FCGA) award for
distinguished service to the Canadian accounting profession. He has been on SFUs Faculty
of Business Administrations Teaching Honour Roll for May 2004 to April 2005 and May
2006 to April 2007. In August 2008, he was one of the two annual winners of the Business
Facultys TD Canada Trust Distinguished Teaching Award. Stephen has held a number of
volunteer positions with CGA-BC; he currently sits on CGA-BCs board of governors where
he is CGA-BCs President.

International Accounting Standard 37, Provisions, Contingent Liabilities and Contingent Assets 9