IAS 37 — Provisions and

Contingent Liabilities
and Assets

Zubair Saleem FR-II Study Notes 1

 Definition & Scope

Provision: A liability of uncertain time and amount

Eg. Warranties,refund policy & etc.

Accruals are liabilities to pay for goods or services that have been

received or supplied but not yet invoiced. There is often a degree of

estimation in the measurement of accruals but any inherent

uncertainty is much less than for provisions

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 Definition & Scope

In some countries the term “provision” is also used to describe the

reduction in the value of an asset.

For example accountants might talk of provision for depreciation,

provision for doubtful debts and so on. These “provisions” are not

covered by this standard which is only about provisions that are

liabilities
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 Criteria
▪ of economic benefits

▪ Reliable estimate Present obligation arising from past events

▪ Probable outflow

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 Criteria
Obligation

Legal obligation Constructive obligation

By contract Pattern of past practice

By legislation Valid expectation

By other operators of law Other party doesn’t have

rights but ethical reason to
Other party has right to
believe that there is an
enforce
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obligation
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 Double Entry
Debit Credit
Profit or Loss(expense)/ Asset x
Provision x
De-recognition of a provision that is no longer needed
Provision x
Income Statement x
Increase in a provision
Profit or loss (expense) x
Provision x
Decrease in a provision
Provision x
Profit or loss x
Provision x
Cash x
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Example
31 December 2016

A company was sued by a customer in the year ended 31 December

2016. Legal advice is that the customer is virtually certain to win the case
as several similar cases have already been decided in the favour of the
injured parties. At 31 December 2016, the company’s lawyer was of the
opinion that, the cost of the settlement would be Rs.1,000,000.

31 December 2017

The claim has still not been settled. The lawyer now advises that the claim
will probably be settled in the customer’s favour at Rs.1,200,000.
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Example
31 December 2018

The claim has still not been settled. The lawyer now believes that the claim
will be settled at Rs.900,000.

31 December 2019

The claim is settled for Rs.950,000.

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 Measurement

▪ Time value of money

▪ Risk and reward should be considered

One-off event Multiple event payment

Best available estimate Expected value

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Example

▪ Future repairs, inspections, overhauling, improvements - No provision required

Reason: No obligation is present as it depends on your decision, third party is

not involved for Payment. No obligating event because future expenses
don’t require provisions

▪ Environmental provisions - Yes, if the environment is already damaged

Reason: Obligation is present due to past event - environmental damage

▪ Future operational losses - No provision is required

▪ Onerous contracts - Provision is required as contract is already made

Reason: loss making contracts/unavoidable cost exceeds benefits

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 Sale or Closure of Operations
Sale of operation Closure of operation
criteria criteria

▪ Publically announced ▪ Publically announced

▪ Binding sales agreement ▪ Detailed formal plan

Note1: Redundancy payments and breach of contract compensation

require provision
Note 2: Relocation expenses and training expenses for new operations.
Expected loss – apply impairment test.
Self insurance doesn’t require provision
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Example
Gujrat Prefabricators Limited (GPL) has won a contract to provide
temporary accommodation for workers involved in building a new airport.
The contract involves the erection of accommodation blocks on a public
park and two years later the removal of the blocks and the reinstatement
of the site. The blocks have been built and it is now GPL’s year-end. GPL
estimates that the task of removing the blocks and reinstating the park to
its present condition might be complex, resulting in costs with a present
value of Rs. 2,000,000, or straightforward, resulting in costs with a present
value of Rs. 1,300,000. GPL estimates that there is a 60% chance of the job
being straightforward.

Should a provision be recognised and if so at what value?

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Example – contd.
Analysis: Should a provision be recognised?

Is there a present obligation as a result of a past event?

Yes. A present obligation arises due to the existence of a contractual term

and the building of the block.

Is it probable that there will be an outflow of economic benefits to settle

the obligation?

Yes. This is certain.

Can a reliable estimate be made of the amount of the obligation?

Yes. Data is available. A provision should be recognised.

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Example – contd.
How should the provision be measured? (What is the best estimate of
expenditure required to settle the obligation?)

The most likely outcome is that the job will be straightforward. In this case
the provision would be recognised at Rs.1,300,000. However there is a
significant chance that the job will be complex so perhaps GPL should
measure the liability at the higher amount. This may sound a little vague
but in practice this comes down to a matter of judgement.

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Example
Sahiwal Manufacturing has sold 10,000 units in the year. Sales accrued
evenly over the year. It estimates that for every 100 items sold, 20 will
require small repairs at a cost of Rs.100, 10 will require substantial repairs at
a cost of Rs.400 each and 5 will require major repairs or replacement at a
cost of Rs.800 each. On average the need for a repair becomes apparent
6 months after a sale.

What is the closing provision?

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Example
A provision will be required for the sales in the second six months of the year as
presumably the repairs necessary in respect of the sales in the first six months
have been completed by the year end. Sales accrue evenly, therefore, the
sales in the second six months are 5,000 units (6/12 x 10,000).

Repair No. of Units Cost per repair (Rs.) Total (Rs.)

Small 20% x 5,000 = 1,000 100 100,000

Substantial 10% of 5,000 = 500 400 200,000

Major Provision 5% of 5,000 = 250 800 200,000

500,000

Note that this would be reduced by the repairs already made by the year end
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 Definitions
Contingent Liability Contingent Asset

▪ Not required ▪ Not required

▪ Subsidiary contingent liability at ▪ May be disclosed
acquisition date should be
recognised (IFRS 3)
▪ May be disclosed

Definition:
Possible liability arising from past event
whose existence will be confirmed by
occurrence or non-occurrence of
uncertain future event, not within the
control of the entity
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Definition:
Possible liability arising from past event
whose existence will be confirmed by
occurrence or non occurrence of
uncertain future events, not within the
control of the entity
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 Application

Percentage Provision Asset

Virtually certain (95% & above) Provide provision Recognize as asset

Probable(50%-95%) Provide provision Disclose by notes

Possible (5%-49%) Disclose by notes Do nothing

Remote (5% and below ) Do nothing Do nothing

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 Disclosure
Where disclosure of a contingent liability or a contingent asset is
appropriate, the following disclosures are required:

▪ A brief description of the nature of the contingent liability/asset

▪ Where practicable:

• an estimate of its financial effect

• an indication of the uncertainties.

▪ For contingent liabilities, the possibility of any reimbursement

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 Re-imbursements
In some cases, a part or all of a company’s provision may be

recoverable from a third party.

For example, a company paying out to a customer under the

terms of a guarantee may itself be able to claim money back from

one of its own suppliers.

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 Re-imbursements
IAS 37 requires that such a reimbursement:

should only be recognised where receipt is virtually certain;

And

should be treated as a separate asset in the statement of financial

position (i.e. not netted off against the provision) at an amount no

greater than that of the provision.

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 Re-imbursements
However, IAS 37 allows the expense relating to a provision to be

presented net of the amount recognised for a reimbursement in

the statement of profit or loss.

A reimbursement right is recognized as a separate asset (no

netting off with the provision itself), but you can net off the

expenses for provision with the income from reimbursement in the

profit or loss.
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 Re-imbursements
Reimbursements should be accounted for as follows:

Debit Credit
Asset xxx
Expense xxx

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