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Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Date recorded:

The staff asked the Board to confirm the previous decisions made as set out in the following decision summary:

Definitions of Contingent Assets and Contingent Liabilities

The Board decided to amend the definition of a contingent asset to:

  • A conditional right that arises from past events from which future economic benefits may flow based on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

The Board decided to amend the definition of a contingent liability to:

  • A conditional obligation that arises from past events that may require an outflow of resources embodying economic benefits based on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

Recognition and Measurement of Contingent Assets and Contingent Liabilities

The Board observed that contingent assets (or liabilities) are sometimes accompanied by associated unconditional rights (or obligations) that satisfy the definition of an asset (or liability).

The Board observed that, for a contingent asset that is within the scope of IAS 37, any accompanying unconditional right would be a non-monetary asset without physical substance and, if it satisfied the 'identifiability' criterion in IAS 38 Intangible Assets, it would meet the definition of an intangible asset. The Board therefore decided that an unconditional right that accompanies a contingent asset (that is within the scope of IAS 37) should be accounted for in accordance with IAS 38.

The Board also observed that, for a contingent liability that is within the scope of IAS 37, any accompanying unconditional obligation would meet the definition of a provision (liability). The Board therefore decided that an unconditional obligation that accompanies a contingent liability (that is within the scope of IAS 37) should be accounted for under IAS 37.

The Board also decided that, in the absence of accompanying unconditional rights (or obligations), contingent assets (or liabilities) are themselves not assets (or liabilities) and are not considered for recognition separately as assets (or liabilities) in or outside of a business combination.

Constructive Obligation

The Board decided to amend the definition of a constructive obligation as follows:

  • 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 particular responsibilities; and
    • (b) as a result, the entity has created a valid expectation in those parties that they can reasonably rely on it to discharge those responsibilities.

The Board decided to include additional explanatory material to assist entities in determining whether they have met the definition of a constructive obligation.

Recognition

The Board decided to add to the existing recognition guidance in IAS 37 to explain that the outflow of economic resources required to settle an obligation can be the provision of services. For example, an entity that has issued a product warranty has an unconditional obligation to provide a service for the duration of the warranty. The entity has therefore satisfied the probable outflow criterion (ie IAS 37.14(b)) regardless of the likelihood of the product developing a fault.

Measurement

The Board decided to make the following limited amendments to the existing measurement requirements of IAS 37 for clarification and to remove inconsistencies:

  • (a) Provisions should be measured at the amount that an entity would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party at that time.
  • (b) Using an expected value estimation technique would generally be consistent with the above principle, whilst measuring a provisions at a single point estimate of the most likely outcome would not.
  • (c) Provisions should be remeasured at each reporting date using a current discount rate.

Application Guidance for Provisions for Restructuring Costs

The Board decided to withdraw the existing guidance on provisions for restructuring costs in IAS 37 (paragraphs 70-83) and to specify that that the existence and announcement of a restructuring plan does not by itself create an obligation. The Board decided that IAS 37 should explain that a cost associated with a restructuring is recognised as a provision on the same basis as if that cost arose independently of a restructuring. The Board also decided that it would specify the treatment of costs that are often incurred in a restructuring as follows:

  • (a) The cost of employee termination benefits should be recognised in accordance with IAS 19 (see below).
  • (b) The cost of terminating a contract before the end of its term should be recognised in accordance with the requirements for onerous contracts (see below).
  • (c) The liability for costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity should be recognised in accordance with the requirements for onerous contracts (see below).

Application Guidance for Provisions for Onerous Contracts

The Board decided to specify that if a contract becomes onerous as a result of the entity's own actions, the resulting provision for that contract should not be recognised until that action has occurred. For example, in the case of an operating lease on a property that will become vacant as a result of a restructuring, the provision for the unavoidable lease commitment should be recognised when the entity vacates the property.

The Board decided to specify that if the onerous contract is an operating lease, the provision for the unavoidable lease commitment should be reduced by the sublease rentals that could reasonable be obtained for the property.

Termination Benefits

The Board decided that the principles underlying SFAS 146 should apply to all involuntary termination benefits, not just those that are within the scope of SFAS 146 (ie 'one-time' termination benefits). The Board therefore decided that:

  • (a) The recognition of termination benefits depends on whether those benefits relate to employees' past service or are paid in exchange for employees' future services (ie are a 'stay bonus').
  • (b) Termination benefits are regarded as paid in exchange for employees' future services if they:
    • i. are not provided under the terms of an established benefit arrangement (ie employment contract, legislation, union agreement, prior business practice);
    • ii. do not vest until the employment is terminated; and
    • iii. are provided to employees who will be retained beyond the minimum retention period.
  • (c) No liability for termination benefits is recognised until the entity has communicated its plan of termination to the affected employees.

More specifically:

  • Termination benefits that relate to employees' past services are recognised when the entity has a present obligation to provide termination benefits. In the case of involuntary termination benefits, this is when the entity has a formal plan of termination that it has communicated to the affected employees. In the case of voluntary termination benefits, this is when the employees accept the entity's offer of voluntary redundancy.
  • Termination benefits that are payable in exchange for employees' future services are recognised over that period of future service.

The Board confirmed the decisions subject to wording to clarify that if a provision is measured using an expected value estimation technique, it should be measured, and subsequently remeasured, taking into the risk adjusted measures a third party who assumed the obligation would take into account.

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