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Contingencies: Key differences between U.S. GAAP and IFRSs

Under U.S. GAAP, ASC 450 and ASC 460 are the primary sources of guidance on contingencies.

Under IFRSs, IAS 37, Provisions, Contingent Liabilities and Contingent Assets, is the primary source of guidance on contingencies.

This comparison does not address differences between U.S. GAAP and IFRSs regarding the accounting for issues addressed in other accounting manual sections, including costs associated with restructuring activities and asset retirement obligations (see the asset retirement obligations comparison for a discussion of these differences).

The table below summarizes these differences and is followed by a detailed explanation of each difference.1

Subject

U.S. GAAP

IFRSs

Scope

ASC 450 applies to asset impairments.

IAS 37 does not apply to asset impairments.

Terminology

Three categories:

  • Estimated loss accrued for a loss contingency (i.e., a contingent loss that is recognized as a liability).
  • Contingent loss that is not recognized as a liability.
  • Contingent gain.

Three categories:

  • Provision.
  • Contingent liability.
  • Contingent asset.

Recognition of contingent losses/provisions

One of the conditions for loss accrual is that it is probable that (1) an asset has been impaired or (2) a liability has been incurred. "Probable" is defined as likely, which is a higher threshold than "more likely than not."

One of the conditions for recognizing a provision (as a liability) is that it is probable that an outflow of resources will be required to settle the obligation. "Probable" is defined as more likely than not.

Measurement of contingent losses/provisions — range of estimates

If no amount in the range is more likely than any other amount in the range, the minimum amount in the range is used to measure the amount to be accrued for a loss contingency.

If no amount in the range is more likely than any other amount in the range, the midpoint of the range is used to measure the liability.

Measurement of contingent losses/provisions — discounting

Discounting is permitted only when the timing of related cash flows is fixed or reliably determinable.

Discounting is required if the effect of discounting is material.

Recoveries of contingent losses (reimbursements)

Gain contingencies related to the recovery of contingent losses are recognized when recovery is deemed probable.

Expected reimbursement by other parties is recognized only when it is virtually certain that the reimbursement will be received.

Onerous contracts

Losses on firmly committed onerous contracts are usually not recognized.

If an entity has a contract that is onerous (e.g., an operating lease), the present obligation under the contract should be recognized as a liability.

Disclosure of prejudicial information

Exemptions from disclosure of information that may be prejudicial to an entity are not permitted.

In extremely rare cases, if disclosure of certain information could prejudice the position of the entity in a dispute with other parties, that information does not need to be disclosed. However, an entity must disclose the nature of the dispute, along with the reason why the information has not been disclosed.

Gain contingencies (U.S. GAAP) versus contingent assets (IFRSs)

When realization of a gain contingency is assured beyond a reasonable doubt, recognition is appropriate.

When realization of a contingent asset is virtually certain, recognition is appropriate.

Scope

Under U.S. GAAP, the accounting requirements for contingencies in ASC 450-20 apply to impairment of assets — for example, assessing the collectibility of receivables or the risk of loss or damage of the entity's property (see, for instance, ASC 450-20-05-3 and ASC 450-20-05-10). Under IFRSs, the accounting requirements for contingencies in IAS 37 do not address impairment or other adjustments to the carrying amounts of recognized assets (see paragraph 7 of IAS 37). IAS 36, Impairment of Assets, and IAS 39, Financial Instruments: Recognition and Measurement, contain guidance on asset impairment.

Terminology

U.S. GAAP and IFRSs use different terminology to describe contingencies. Under U.S. GAAP, this terminology is related to financial statements' elements of performance (two key terms are "contingent gains" and "contingent losses"), whereas under IFRSs, the terminology used is related to financial statements' elements of financial position (the three key terms are "contingent assets," "contingent liabilities," and "provisions"). However, the two sets of terms may be applied similarly so that no difference between them arises in practice.

Under U.S. GAAP, ASC 450-20 defines a contingency as an "existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur." If an estimated loss from a loss contingency meets the conditions for loss accrual in ASC 450-20-25-2, the loss contingency is accrued.

Under IFRSs, IAS 37 defines (1) a "contingent asset" as "a possible asset . . . whose existence will be confirmed only by the occurrence or non-occurrence of . . . uncertain future events"; (2) a "contingent liability" as "a possible obligation . . . whose existence will be confirmed only by the occurrence or non-occurrence of . . . uncertain future events . . . or a present obligation that . . . is not recognised"; and (3) a "provision" as "a liability of uncertain timing or amount."

Under U.S. GAAP, a loss contingency that has been accrued as a liability (a "provision" under IFRSs) and a loss contingency that has not been accrued (a "contingent liability" under IFRSs) are not defined separately. In addition, as noted above, the accrual for a loss contingency under ASC 450-20 could involve a valuation adjustment of a recognized asset (e.g., bad debt), whereas IAS 37 does not apply to valuation adjustments of recognized assets.

Recognition of Contingent Losses/Provisions

Under U.S. GAAP, one of the conditions that must be met before an entity can accrue an estimated loss from a loss contingency is that "it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements" — that is, "it must be probable that one or more future events will occur confirming the fact of the loss" (ASC 450-20-25-2(a)). Under IFRSs, one of the conditions for recognizing a provision as a liability is that "it is probable that an outflow of resources . . . will be required to settle the obligation" (paragraph 14 of IAS 37).

A key difference between U.S. GAAP and IFRSs in applying the above conditions lies in the definition of "probable." Paragraph 23 of IAS 37 defines probable as "more likely than not to occur" (i.e., "the probability that the event will occur is greater than the probability that it will not"). ASC 450-20-20 defines "probable" as "likely to occur." While the assessment of these terms is subject to an entity's judgment, "likely" under U.S. GAAP typically is considered a much higher threshold (i.e., approximately 80 percent) than "more likely than not" under IFRSs (i.e., greater than 50 percent). Therefore, more contingencies may qualify for recognition as liabilities under IFRSs than under U.S. GAAP.

Measurement of Contingent Losses/Provisions — Range of Estimates

Under both U.S. GAAP and IFRSs, the amount recorded as a loss contingency or provision should be the best estimate of the expenditure required to settle the obligation. If the best estimate of the expenditure is a range, and if one amount in that range represents a better estimate than any other amount within the range, that amount should be recorded (ASC 450-20-30-1 and paragraph 36 of IAS 37).

Under U.S. GAAP, if no amount in the range is a better estimate than any other amount, an entity should use the minimum amount in the range for recording the liability (ASC 450-20-30-1). In contrast, under IFRSs, if no amount in the range is a better estimate than any other amount, an entity should use the midpoint of the range for recording the liability (paragraph 39 of IAS 37). If the obligation involves a large population of items, an entity should estimate the liability by weighting all possible outcomes by their associated probabilities (i.e., the probability-weighted expected value is used to measure the liability).

Measurement of Contingent Losses/Provisions — Discounting

Under U.S. GAAP, discounting of contingencies is generally not appropriate unless both the timing and the amounts of future cash flows are fixed or reliably determinable. The ability to reliably determine such timing and amounts is based on objective and verifiable information.

Under IFRSs, in situations in which discounting may be material, the amount of a provision should be the present value of the future expenditures expected to settle the obligation. See paragraphs 45–47 of IAS 37 for further discussion.

Recoveries of Contingent Losses (Reimbursements)

Under U.S. GAAP, gain contingencies related to the recovery of contingent losses typically are recognized when realization of the claim for recovery of a loss recognized in the financial statements is deemed probable.

Under IFRSs, expected reimbursements of expenditures required to settle a provision are recognized only when it is virtually certain that the reimbursements will be received (paragraph 53 of IAS 37).

While the guidance on this issue is worded differently under IFRSs and U.S. GAAP, the guidance under both sets of standards may be applied similarly so that no difference arises in practice.

Onerous Contracts

Under U.S. GAAP, losses on firmly committed executory contracts (e.g., purchase, sale, or operating lease contracts) typically are not recognized.

Under IFRSs, an entity is required to recognize and measure the present obligation under an onerous contract as a provision (paragraphs 66–69 of IAS 37). An onerous contract is one "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 fulfil it."

Disclosure of Prejudicial Information

Paragraph 92 of IAS 37 discusses situations in which an entity may be in a dispute with other parties and not wish to disclose information that it may deem to be prejudicial for fear that such disclosure will influence the outcome of the dispute. In these extremely rare cases, an entity may forgo disclosure of such information provided that it discloses the general nature of the dispute and the fact that the information has not been disclosed, along with an explanation of why it has not been disclosed. Such an exemption is currently not allowed under U.S. GAAP.

Gain Contingencies Versus Contingent Assets

Under both U.S. GAAP and IFRSs, the standard for recognition of a gain contingency (or contingent asset) is substantially higher than the standard for recognition of a loss contingency.

Under U.S. GAAP, a gain contingency is recognized if realization is assured beyond a reasonable doubt. Therefore, virtually all uncertainties, if any exist, about the timing and amount of realization of a gain contingency should be resolved before the gain is recognized in the financial statements.

Under IFRSs, a contingent asset is not recognized in the financial statements. Paragraph 33 of IAS 37 states that "when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate" (emphasis added).

While the guidance on this issue is worded differently under IFRSs and U.S. GAAP, the guidance under both sets of standards may be applied similarly so that no difference arises in practice.

____________________

1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.