Indian Accounting Standard (Ind AS 37), Provisions, Contingent Liabilities and Contingent Assets
The objective of Ind AS 37 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.
Ind AS 37 prescribes the accounting and disclosures for provisions, contingent liabilities and contingent assets, except:
(a) those resulting from executory contracts, except where the contract is onerous; and
(b) those covered by another Standard.
Ind AS 37 also do not apply to financial instruments (including guarantees) that are within the scope of Ind AS 109, Financial Instruments.
A provision is a liability of uncertain timing or amount.
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
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 legal obligation is an obligation that derives from:
(a) a contract (through its explicit or implicit terms);
(b) legislation; or
(c) other operation of law.
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 provision shall be recognised if and only if:
(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) payment is probable (more likely than not); and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, provision shall not be recognised.
Provisions shall be reviewed at the end of each reporting period 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 shall be reversed.
In rare cases where it is not clear whether there exists a present obligation, a past event is deemed to give rise to a present obligation if, after taking account of all available evidence, it is more likely that a present obligation may exist at the end of the reporting period.
The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time.
Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes.
Best estimate – The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. In reaching its best estimate, the entity should take into account the risks and uncertainties that surround the underlying events.
Time value of money – Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation.
Future events – Future events that may affect the amount required to settle an obligation shall be reflected in the amount of a provision where there is sufficient objective evidence that they will occur.
- Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount.
- Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value.
- Both measurements are at discounted present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the liability.
- In measuring a provision consider future events as follows:
- forecast reasonable changes in applying existing technology;
- ignore possible gains on sale of assets;
- consider changes in legislation only if virtually certain to be enacted.
Expected disposal of assets – Gains from the expected disposal of assets shall not be taken into account in measuring a provision.
Reimbursements – Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognised for the reimbursement shall not exceed the amount of the provision. In the statement of profit and loss, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.
If an entity has a contract that is onerous, the present obligation under the contract shall be recognised and measured as a provision. This Standard defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it.
A provision for restructuring costs is recognised only when the general recognition criteria for provisions are met.
With respect to restructuring obligation, the Standard provides guidance for application of general recognition conditions that need to be complied with for recognition of restructuring provision and identification of expenses that are in the nature of restructuring cost.
A restructuring is :
- sale or termination of a line of business;
- closure of business locations;
- changes in management structure; or
- fundamental reorganisations.
Restructuring provisions should be recognised as follows:
- Sale of operation: recognise a provision only after a binding sale agreement.
- Closure or reorganisation: recognise a provision only after a detailed formal plan is adopted and has started being implemented, or announced to those affected. A board decision of itself is insufficient.
- Future operating losses: provisions are not recognised for future operating losses, even in a restructuring.
- Restructuring provision on acquisition: recognise a provision only if there is an obligation at acquisition date.
Restructuring provisions should include only direct expenditures necessarily entailed by the restructuring, not costs that associated with the ongoing activities of the entity.
Contingent liabilities and assets
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 recognised 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.
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.
An entity shall not recognise contingent assets or liabilities.
Appendix A of Ind AS 37 provides guidance on (a) how a contributor account for its interest in a fund and (b) when a contributor has an obligation to make additional contributions, for example, in the event of the bankruptcy of another contributor or if the value of the investment assets held by the fund decreases to an extent that they are insufficient to fulfil the fund’s reimbursement obligations, how that obligation be accounted for. The Appendix prescribes that the contributor shall recognise its obligation to pay decommissioning costs as a liability and recognise its interest in the fund separately unless the contributor is not liable to pay decommissioning costs even if the fund fails to pay. When a contributor has an obligation to make potential additional contributions, this obligation is a contingent liability that is within the scope of Ind AS 37. The contributor shall recognise a liability only if it is probable that additional contributions will be made.
Appendix B of Ind AS 37 provides guidance on the recognition, in the financial statements of producers, of liabilities for waste management under the European Union’s Directive on Waste Electrical and Electronic Equipment (WE&EE), in respect of sales of historical household equipment. This Appendix addresses neither new waste nor historical waste from sources other than private households. The liability for such waste management is adequately covered in Ind AS 37. However, if, in national legislation, new waste from private households is treated in a similar manner to historical waste from private households, the principles of this Appendix apply by reference to the hierarchy in paragraphs 10-12 of Ind AS 8. The Ind AS 8 hierarchy is also relevant for other regulations that impose obligations in a way that is similar to the cost attribution model specified in the EU Directive.
Appendix C to Ind AS 16 addresses the accounting for a liability to pay a levy if that liability is within the scope of Ind AS 37. It also addresses the accounting for a liability to pay a levy whose timing and amount is certain. The Appendix prescribes that obligating event that gives rise to a liability to pay a levy is the activity that triggers the payment of the levy, as identified by the legislation. An entity does not have a constructive obligation to pay a levy that will be triggered by operating in a future period as a result of the entity being economically compelled to continue to operate in that future period. The liability to pay a levy is recognised progressively if the obligating event occurs over a period of time.