Accounting Standard (AS) 29: Provisions, Contingent Liabilities and Contingent Assets (Revised)
The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and that sufficient information is disclosed in the notes to the financial statements. The objectives of this Standard is also to lay down appropriate accounting for contingent assets.
AS 29 should be applied in accounting for provisions and contingent liabilities and in dealing with contingent assets, other than
- Those resulting from financial instruments that are carried at fair value;
- Those resulting from executory contracts except where the contract is onerous;
- Those arising in insurance enterprises from contracts with policy-holders; and
- Those covered by another Accounting Standard.
Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent.
A Provision is a liability which can be measured only by using a substantial degree of estimation.
A Liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
An Obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.
A Contingent liability is:
- A possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
- A present obligation that arises from past events but is not recognised because:
- It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
- A reliable estimate of the amount of the obligation cannot be made.
A Contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise.
Present obligation – an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not.
Possible obligation – an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable.
A Restructuring is a programme that is planned and controlled by management, and materially changes either:
- The scope of a business undertaken by an enterprise; or
- The manner in which that business is conducted.
A provision should be recognised when:
- An enterprise 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; and
- A reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision should be recognised.
An enterprise determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, e.g., the opinion of experts. On the basis of such evidence:
- Where it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognises a provision (if the recognition criteria are met); and
- Where it is more likely that no present obligation exists at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.
A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.
Financial statements deal with the financial position of an enterprise at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date.
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. For the purpose of AS 29, 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 enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.
Where there are a number of similar obligations (e.g., product warranties or similar contracts) the probability that an outflow will be required in settlement is determined by considering the class of obligations as a whole. Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is recognised (if the other recognition criteria are met).
Reliable Estimate of the Obligation
The use of estimates is an inherent part of preparing financial statements and does not undermine their reliability. Provisions require a greater degree of estimation than most other items, but AS 29 (Revised) emphasises that it should not be impossible to determine a range of possible outcomes and, from this range, to reach an appropriate conclusion that is sufficiently reliable for the provision to be recognised. AS 29 (Revised) concludes that the circumstances in which it will not be possible to reach a reliable estimate, will be extremely rare.
In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability will, instead, be disclosed as a contingent liability.
An enterprise should not recognise a contingent liability but should be disclosed. A contingent liability is disclosed, unless the possibility of an outflow of resources embodying economic benefits is remote.
Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability.
The enterprise recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made.
Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the enterprise. An example is a claim that an enterprise is pursuing through legal processes, where the outcome is uncertain.
An enterprise should not recognise a contingent asset, since this may result in the recognition of income that may never be realised.
The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date.
The estimates of outcome and financial effect are determined by the judgment of the management of the enterprise, supplemented by experience of similar transactions and, in some cases, reports from independent experts.
Risks and uncertainties
The risks and uncertainties that inevitably surround many events and circumstances should be taken into account in reaching the best estimate of a provision.
It is only those obligations arising from past events that exist independently of the enterprise’s future actions (ie the future conduct of its business) that are recognised as provisions.
Future events that may affect the amount required to settle an obligation should 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. Instead, an enterprise recognises gains on expected disposals of assets at the time specified by the Accounting Standard dealing with the assets concerned.
An, enterprise with a present obligation may be able to seek reimbursement of part or all of the expenditure from another party, for example via:
- An insurance contract arranged to cover a risk;
- An indemnity clause in a contract; or
- A warranty provided by a supplier.
Changes in Provisions
Provisions should be reviewed at each balance sheet date 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 should be reversed.
Use of Provisions
A provision should be used only for expenditures for which the provision was originally recognised. Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.
Application of the Recognition and Measurement Rules
Future Operating Losses
Future operating losses do not meet the definition of a liability and the general recognition criteria, therefore provisions should not be recognised for future operating losses.
The following are examples of events that may fall under the definition of restructuring:
- Sale or termination of a line of business
- The closure of business locations in a country or region or the relocation of business activities from one country or region to another
- Changes in management structure, for example, eliminating a layer of management
- Fundamental re-organisations that have a material effect on the nature and focus of the enterprise’s operations
A provision for restructuring costs is recognised only when the recognition criteria for provisions are met.
Disclosure of provision in financial statements –
- Opening balance
- Addition to and use of the provision
- Unused amount written back
- Closing balance
Other required disclosures are –
- brief description of provision
- Major assumption on future events made at the time of measuring the provision and indication of uncertain items
- Any expected reimbursement is to be recognised as an asset.
Disclosure of contingent liability at the balance sheet date –
- description of the nature of the contingent liability;
- where required, an estimate of the amount as per measurement principles as prescribed for provision;
- indications of the uncertainties relating to outflow;
- possibility of any reimbursement;
- Where any of the information required as above is not disclosed because, that fact should be stated.