IAS 37

Provisions, Contingent
Liabilities and
Contingent Assets

Saturday, March 22, 202 AAUSC IFRS Project Office 1

 Objective
ThisStandard prescribes rules
IAS 37

regarding
◦ the recognition and measurement of
 provisions,
 contingent liabilities, and
 contingent assets and
◦ also mandates
 disclosures in footnotes
 that would enable users of financial
statements to understand their nature,
timing, and amount.
Saturday, March 22, 202 AAUSC IFRS Project Office 2
 Definitions of Key Terms
 Liability: is a present obligation of an
entity arising from past events, the
IAS 37

settlement of which is expected to result in

an outflow of resources embodying
economic benefits.
 Provision: is a liability of uncertain
timing or amount.
 Contingent Liability.
a) A possible obligation arising from past
events whose existence will be confirmed only
by the occurrence or nonoccurrence of one or
more uncertain future events that are not
completely within the22,control
Saturday, March 202 AAUSCof
IFRS the entity;
Project Office 3
 Definitions (Cont’d…)
b)A present obligation that arises from
past events but is not recognized
IAS 37

because either
• it is not possible to measure the
amount of the obligation with
sufficient reliability or
• it is not probable that an outflow of
resources will be required to settle the
obligation.
 Contingent Asset: is possible asset
arising from past events and whose
existence will be confirmed only by the
occurrence or nonoccurrence
Saturday, March 22, 202 of Office
AAUSC IFRS Project one or 4
 Definitions (Cont’d…)
An Obligating Event is
IAS 37

◦ an event
 that creates a legal or constructive
obligation
 that results in an entity having no
realistic alternative but to settle
that obligation.

Saturday, March 22, 202 AAUSC IFRS Project Office 5

 Recognition - Provisions
 Provisions should be recognized when, and
only when, all of these conditions are met:
IAS 37

a) An entity has a present legal or constructive

obligation resulting from a past event;
b) It is probable that an outflow of resources embodying
economic benefits would be required to settle the
obligation; and
c) A reliable estimate can be made of the amount of
the obligation.
 Creditors
(Trade Payables) and Accrued
Expenses are not considered “provisions” by this
Standard
◦ because they do not entail either uncertain
timing or amount.
Saturday, March 22, 202 AAUSC IFRS Project Office 6
IAS 37

Provisions, Contingent Assets and

Liabilities (IAS 37)
Saturday, March 22, 202 AAUSC IFRS Project Office 7
 Provisions (Cont’d…)
An obligation could either be
IAS 37

a)a legal obligation or

b)a constructive obligation.
A legal obligation is an obligation
that could
a)Be contractual; or
b)Arise due to a legislation; or
c) Result from other operation of law.

Saturday, March 22, 202 AAUSC IFRS Project Office 8

 Provisions (Cont’d…)
A Constructive Obligation, however, is an
obligation that results from an entity’s
IAS 37

actions where
a) By an established pattern of past
practice, published policies, or a
sufficiently specific current
statement, the entity has indicated to
other (third) parties that it will accept
certain responsibilities; and
b) As a result, the entity has created a valid
expectation in the minds of those
parties that it will discharge those
responsibilities.
Saturday, March 22, 202 AAUSC IFRS Project Office 9
 Provisions (Cont’d…)
It should be
IAS 37

◦ “probable that the outflow of

resources embodying economic
benefits would occur.”
The term “probable” is
interpreted, for the purposes of
this Standard, as
◦ “more likely than not”
◦ (i.e., the chances of occurrence
are moreSaturday,
than March50%).
22, 202 AAUSC IFRS Project Office 10
 Case Study 1_10 Minutes
Facts
 Excellent Inc. is an oil entity that is exploring oil off the shores of
Excessoil Islands. It has employed oil exploration experts from
IAS 37

around the globe. Despite all efforts, there is a major oil spill that
has grabbed the attention of the media. Environmentalists are
protesting and the entity has engaged lawyers to advise it about
legal repercussions. In the past, other oil entities have had to settle
with the environmentalists, paying huge amounts in out-of-court
settlements. The legal counsel of Excellent Inc. has advised it that
there is no law that would require it to pay anything for the oil spill;
the parliament of Excessoil Islands is currently considering such
legislation, but that legislation would probably take another year to
be finalized as of the date of the oil spill. However, in its television
advertisements and promotional brochures, Excellent Inc. often
has clearly stated that it is very conscious of its responsibilities
toward the environment and will make good any losses that may
result from its exploration. This policy has been widely publicized,
and the chief executive officer has acknowledged this policy in
official meetings when members of the public raised questions to
him on this issue. Saturday, March 22, 202 AAUSC IFRS Project Office 11
 Solution
a) Present obligation as a result of a past obligating
event. The obligating event is the oil spill. Because
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there is no legislation in place yet that would make

cleanup mandatory for any entity operating in Excessoil
Islands, there is no legal obligation. However, the
circumstances surrounding the issue clearly indicate
that there is a constructive obligation since the
company, with its advertised policy and public
statements, has created an expectation in the minds of
the public at large that it will honor its environmental
obligations.
b) An outflow of resources embodying economic benefits
in settlement. Probable.
c) Conclusion. A provision should be recognized for the
best estimate of the cost to clean up the oil spill.
Saturday, March 22, 202 AAUSC IFRS Project Office 12
 Measurement-Provisions
 The amount to be recognized as a provision is
◦ the best estimate of the expenditure
◦ required to settle the present obligation at the balance
IAS 37

sheet date.
 “Best Estimate”
◦ is a matter of judgment and is usually based on
 past experience with similar transactions,
 evidence provided by technical or legal experts, or
 additional evidence provided by events after the balance
sheet date.
 Risks and uncertainties surrounding events and
circumstances should be considered in arriving at the best
estimate of a provision.
◦ If a group of items is being measured, it is the “expected
value.”
◦ If a single obligation is being measured, it is the “most likely
Saturday, March 22, 202 AAUSC IFRS Project Office 13
outcome.”
 Provisions – measurement
of a single obligation
Example 1
• Entity A has manufactured and delivered a custom-designed ship
and has a warranty obligation to repair any faults in the next
12 months
• management estimates the following two possible outcomes, their
associated probability and cost:
o no faults: 20% probability, zero cost
o normal faults: 80% probability, cost CU10,000.
What is the accounting treatment in accordance with
IAS 37 (ignoring the time value)?

A provision of CU10,000 is an appropriate 'best

estimate' since the most likely outcome is CU10,000.
 Provisions – measurement of a single
obligation
Example 2

• Entity B has manufactured and delivered a custom-designed ship

and has a warranty obligation to repair any faults in the next 12
months
• management estimates the following three possible
outcomes, their associated probability and cost:
o no faults: 25% probability, zero cost
o normal faults: 40% probability, cost CU10,000
What is thefaults:
o major accounting treatment in
35% probability, accordance
cost CU100,000.with IAS 37
(ignoring the time value)?
a provision of CU39,000 (being: CU10,000*40%+
CU100,000*35%) is an appropriate 'best estimate'.
 Case Study 2_10 Minutes
Facts
 A car dealership also owns a workshop that it uses for
IAS 37

servicing cars under warranty. In preparing its financial

statements, the car dealership needs to ascertain the
provision of warranty that it would be required to provide at
year-end. The entity’s past experience with warranty claims
is
• 60% of cars sold in a year have zero defects.
• 25% of cars sold in a year have normal defects.
• 15% of cars sold in a year have significant defects.
 The cost of rectifying a “normal defect” in a car is Birr
10,000. The cost of rectifying a “significant defect” in a car is
Birr 30,000.
Required
Compute the amount of “provision for warranty” needed at
year-end. Saturday, March 22, 202 AAUSC IFRS Project Office 16
 Solution
 The expected value of the provision
for warranty needed at year-end is:
IAS 37

(60% × Birr 0) + (25% × Birr 10,000) + (15% × Birr 30,000) = Birr

7,000.

Note
 Where the effect of time value is
material, the amount of provision is to
be discounted to its present value using
a pretax discount rate that reflects
current market assessments of time
value of money and the risks specific to
the liability.
Saturday, March 22, 202 AAUSC IFRS Project Office 17
Common
Common Types
Types of
of Provisions
Provisions
Common Types:

1. Lawsuits 4. Onerous contracts

2. Warranties 5. Restructuring

3. Environmental

IFRS requires extensive disclosure related to provisions in the notes to

the financial statements, however companies do not record or report in
the notes general risk contingencies inherent in business operations
(e.g., the possibility of war, strike, uninsurable catastrophes, or a
business recession).
 Common
Common Types
Types of
of Provisions
Provisions
Litigation Provisions

Companies must consider the following in

determining whether to record a liability with
respect to pending or threatened litigation.

1. Probability of an unfavorable outcome.

2. Ability to make a reasonable estimate of the amount of

loss.

Accountants must generally rely on attorneys’ assessments

concerning the likelihood of such events
 Common
Common Types
Types of
of Provisions
Provisions
Example: Scorcese Inc. is involved in a lawsuit at December 31,
2010. (a) Prepare the December 31 entry assuming it is probable that
Scorcese will be liable for $900,000 as a result of this suit. (b) Prepare
the December 31 entry, if any, assuming it is not probable that
Scorcese will be liable for any payment as a result of this suit.

(a) Lawsuit loss 900,000

Provision for Lawsuit 900,000

(b) No entry is necessary. The loss is not accrued because it

is not probable that a liability has been incurred at
12/31/10. Only disclosure of the fact , no recognition
Common
Common Types
Types of
of Provisions
Provisions
Warranty Provisions
BE13-13: Streep Factory provides a 2-year warranty with one of its
products which was first sold in 2010. In that year, Streep spent
$70,000 servicing warranty claims. At year-end, Streep estimates that
an additional $400,000 will be spent in the future to service warranty
claims related to 2010 sales. Prepare Streep’s journal entry to record
the $70,000 expenditure, and the December 31 adjusting entry.

2010 Warranty expense 70,000

Cash 70,000
12/31/10 Warranty expense 400,000
Provision for warranty claim 400,000
 Common
Common Types
Types of
of Provisions
Provisions
Onerous Contract Provisions
“The unavoidable costs of meeting the obligations exceed
the economic benefits expected to be received.”

The expected costs should reflect the least net cost of

exiting from the contract, which is the lower of

1. the cost of fulfilling the contract, or

2. the compensation or penalties arising from failure to

fulfill the contract.
 Common
Common Types
Types of
of Provisions
Provisions
Onerous Contract Provisions
Illustration: Sumart Sports operates profitably in a factory that it
has leased and on which it pays monthly rentals. Sumart decides
to relocate its operations to another facility. However, the lease on
the old facility continues for the next three years. Unfortunately,
Sumart cannot cancel the lease nor will it be able to sublet the
factory to another party. The expected costs to satisfy this onerous
contract are €200,000. In this case, Sumart makes the following
entry.
Loss on lease contract 200,000
Lease contract liability 200,000
 Common
Common Types
Types of
of Provisions
Provisions
Onerous Contract Provisions
Assume the same facts as above for the Sumart example and the
expected costs to fulfill the contract are €200,000. However,
Sumart can cancel the lease by paying a penalty of €175,000. In
this case, Sumart should record the liability as follows.

Loss on lease contract 175,000

Lease contract liability 175,000
 Case Study 3_10 Minutes
Facts
 XYZ Inc. is getting ready to move its factory from its
IAS 37

existing location to a new industrial free zone specially

created by the government for manufacturers. To avail itself
of the preferential licensing offered by the local
governmental authorities as a reward for moving into the
free trade zone and the savings in costs that would ensue
(since there are no duties or taxes in the free trade zone),
XYZ Inc. has to move into the new location before the end
of the year. The lease on its present location is non
cancelable and is for another two years from year-end. The
obligation under the lease is the annual rent of Birr 100,000.
Required
 Advise XYZ Inc. what amount, if any, it needs to provide at
year-end toward this lease obligation.

Saturday, March 22, 202 AAUSC IFRS Project Office 25

 Solution
 The lease agreement is an executory onerous
contract because after moving to the new
location, XYZ Inc. would derive no economic
IAS 37

benefits from the existing factory building but

would still need to pay rent under the
agreement since the lease is non-cancelable.
Thus the unavoidable costs exceed the
benefits expected under the lease contract.
 Based on the annual lease obligation under the
lease agreement, the total amount needed to be
provided at year-end is the present value of the
total commitment under the lease = PV of [Birr
100,000 × 2 (years)].
Saturday, March 22, 202 AAUSC IFRS Project Office 26
Common
Common Types
Types of
of Provisions
Provisions
Provisions for Restructuring
Restructuring is a program that is
planned and is controlled by management
and materially changes one of two
things
1. The scope of a business undertaken by
an entity.
2. The manner in which that business is
conducted.
 Common
Common Types
Types of
of Provisions
Provisions
Examples of restructuring events:
1. The sale or termination of a line of
IAS 37

business.
2. The closure of business locations in a
country or region or the relocation of
business activities from one country region to
another.
3. Changes in management structure, for
example, the elimination of a layer of
management.
4. Fundamental reorganizations that have a
material effect on the nature and focus of
the entity's operations
Saturday, March 22, 202 AAUSC IFRS Project Office 28
 Common
Common Types
Types of
of Provisions
Provisions
A restructuring provision should
include only the direct expenditures
IAS 37

arising from the restructuring, which

are those that are both:
1.Necessarily entailed by the
restructuring; and
2.Not associated with the ongoing
activities of the entity.

Saturday, March 22, 202 AAUSC IFRS Project Office 29

Disclosures
Disclosures Related
Related To
To Provisions
Provisions
A company must provide a reconciliation of its beginning
to ending balance for each major class of provisions,
identifying what caused the change during the period.

In addition,
► Provision must be described and the expected timing
of any outflows disclosed.
► Disclosure about uncertainties related to expected
outflows as well as expected reimbursements
should be provided.
 Contingent liability

A contingent liability is:

1. a POSSIBLE 1. a PRESENT 1. a PRESENT

obligation that obligation that obligation that
arises from past arises from past arises from
events AND events BUT past events
2. its existence will be 2. is not BUT
confirmed only by the recognised 2. is not
occurrence/non‑occur because it is not recognised
rence of uncertain probable that an because the
future events not outflow of amount of the
wholly within the economic benefits obligation
control of the OR will be required OR cannot be
entity reliably
An entity should not recognise a contingent liability
measured
Disclosure only (unless possibility of outflow is remote)
 IAS 37 : Contingent Liabilities
 They should not be recognized in F/S
but they should be disclosed unless they
IAS 37

are remote.
 Once recognized as a contingent
liability, an entity should continually
assess the probability of the outflow of the
future economic benefits relating to that
contingent liability.
 If the probability of the outflow of the
future economic benefits changes to
more likely than not, then the
contingent liability may develop into an
Saturday, March 22, 202 AAUSC IFRS Project Office 32
 Disclosures
The required disclosures are:
1. A brief description of the nature of the
IAS 37

contingent liability.
2. An estimate of its financial effect.
3. An indication of the uncertainties
that exist.
4. The possibility of any reimbursement.

Saturday, March 22, 202 AAUSC IFRS Project Office 33

Provisions and contingent
liabilities
Decision tree
Present obligation
No Possible No
as a result of
an obligating event obligation

Yes Yes

No Yes
Probable Remote
outflow
No
Yes
No (rare)
Reliable estimate
Yes

PROVIDE DISCLOSE DO NOTHING

Contingent
Liability
Contingent Assets
1.Possible asset that arises from past events
and
2. whose existence will be confirmed only by the
occurrence or non-occurrence of uncertain
future events not wholly within the entity’s
control
How likely is realisation of income?

Not probable but

virtually
probable? not virtually
certain?
certain?
Recogni
Do Disclos se
nothin e under
g only applica
ble IFRS
Contingent asset Actual asset
IAS 37 : Example of Contingent Asset &
Liability
A legal dispute which the outcome is not yet
known, a number of possibilities arise:
1. It expects to have to pay about $100,000. A provision
is recognized.
2. Possible damages are $100,000 but it is not expected
to have to pay them. A contingent liability is
disclosed.
3. The company expects to have to pay damages but is
unable to estimate the amount. A contingent liability
is disclosed.
4. The company expects to receive damages of $100,000
and this is virtually certain. An asset is recognized.
5. The company expects to probably receive damages of
$100,000. A contingent asset is disclosed.
6. The company thinks it may receive damages, but it is
not probable. No disclosure.
Saturday, March 22, 202 AAUSC IFRS Project Office 36
 Case Study _10 Minutes
Facts
A Singapore-based shipping company
IAS 37

lost an entire shipload of cargo valued at Birr

5 million on a voyage to Australia. It is,
however, covered by an insurance policy.
According to the report of the surveyor the
amount is collectible, subject to the
deductible clause (i.e., 10% of the claim) in
the insurance policy. Before year-end, the
shipping company received a letter from the
insurance company that a check was in the
mail for 90% of the claim.
Saturday, March 22, 202 AAUSC IFRS Project Office 37
 Case Study 5 Cont’d…
 The international freight forwarding company
that entrusted the shipping company with the delivery
IAS 37

of the cargo overseas has filed a lawsuit for Birr 5

million, claiming the value of the cargo that was lost
on high seas, and also consequential damages of Birr
2 million resulting from the delay. According to the
legal counsel of the shipping company, it is probable
that the shipping company would have to pay the Birr
5 million, but it is a remote possibility that it would
have to pay the additional Birr 2 million claimed by the
international freight forwarding company, since this
loss was specifically excluded in the freight
forwarding contract.
Required
◦ What provision or disclosure would the
shipping company need
Saturday, March to make
22, 202 at
AAUSC IFRS year-end?
Project Office 38
 Solution
 The shipping company would need to
recognize an asset of Birr 4.5 million (the
IAS 37

amount that is virtually certain of

collection).
 Also it would need to make a provision for
Birr 5 million toward the claim of the
international freight forwarding company.
 Because the probability of the claim of Birr
2 million is remote, no provision or
disclosure would be needed for that.

Saturday, March 22, 202 AAUSC IFRS Project Office 39

Summary
Summary