IAS 37: Provisions, Contingent Liabilities and Contingent Assets
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International Accounting Standard 37: Provisions, Contingent Liabilities and Contingent Assets became effective for annual financial statements relating to periods beginning on or after 1 July 1999 reported under International Accounting Standards.
The Standard provides guidance on the recognition and measurement of provisions, contingent liabilities and contingent assets.
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[edit] Provisions
A provision is defined by IAS 37 as a liability of uncertain timing or amount.
In order for a provision to be recognised in accounts, it must meet the following criteria:
- it is a present obligation (legal or constructive) 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;
- it can be reliably estimated.
In simple terms, these definitions mean that a provision is an uncertain but probable (greater than 50% chance) future cost that exists because of an event in the past.
[edit] Legal and constructive obligations
A legal obligation is a responsibility that arises from contract, legislation or other law.
A constructive obligation derives from past practice or published statements which create a valid expectation regarding responsibilities of the parties involved.
An example of a constructive obligation is established practice of issuing a refund to a customer or a free repair, beyond the customer's contractual or statutory rights.
[edit] Measurement
A provision should be allocated for the best estimate available of the cost involved in settling the obligation at the balance sheet date. The provision should be reviewed at each balance sheet date and the amount adjusted to reflect the current best estimate.
The Standard allows for an expected value to be used for a large group of items.
[edit] Applications
- A provision cannot be recognised for future operating losses.
- A provision should be recognised for onerous contracts. These are contracts where the unavoidable costs of completing the contract are greater than the benefits. The provision should be measured at the lower of the cost of failing to complete the contract (including penalties) and the cost of completion.
- A provision can only be recognised for restructuring a business when a detailed formal plan has been announced or begun to be implemented.
[edit] Contingent Liabilities
The Standard defines a contingent liability as a possible obligation that arises from past events. The entity should not have control over whether the obligation will actually arise in the future.
Possible is interpreted as meaning between a 0% and 50% chance of occurrence.
A contingent liability should not be included in the balance sheet. It should be disclosed in the notes to the financial statements.
[edit] Contingent Assets
A contingent asset is the reverse of a contingent liability, and is defined as a possible asset that arises from past events.
The Standard follows the principle of prudence since it does not allow uncertain assets to be recognised.
[edit] Disclosure requirements
- the contingency nature;
- the uncertain factors that affect the outcome; and
- the financial effect estimate.
[edit] External links
- IASB Summary of IAS 37
- Summary of the IASB's Proposals To Amend IAS 37 and IAS 19 - published by Ernst & Young
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