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Amendments to IAS 37

Date recorded:

Redeliberation of the probability recognition criteria

The Board considered a detailed analysis of the role of probability in the recognition of liabilities. [The staff paper is excellent, and those interested in this area are commended to read it, reproduced in large part as the Observer Note. The explanation of the Board's rationale is much better than that in the Exposure Draft.]

Subject to affirming the measurement requirements proposed in the ED, the Board affirmed its conclusion in the ED, namely that the revised IAS 37 should not include a probability recognition criterion.

However, instead of just explaining that the criterion has been omitted because it is always satisfied, the staff recommends developing a more comprehensive explanation that captures the following points:

  • The probability criterion as articulated in the Framework is confused. Furthermore, it is flawed, because in the absence of the notion of a stand-ready obligation, it results in the obviously anomalous conclusion that liabilities such as guarantees, warranties, and insurance obligations should not be recognised until it is probable that claims will arise. Most such obligations would therefore not initially qualify for recognition. Accordingly, the Framework concept that we should be focussing on in the IAS 37 project is the liability definition.
  • The only standard that, in practice, currently uses the probability recognition criterion to determine recognition is IAS 37. Furthermore, IAS 37 has established its own unique interpretation of probability.
  • The probability recognition criterion as articulated in the current IAS 37 is not related to resolving element uncertainty. Hence, once an entity has concluded that it has a liability, the criterion, as articulated in the current IAS 37, would in most cases not be a determining factor in recognition.
  • The notion of a stand ready obligation is a logical extension of the existing Framework. Contractual stand ready obligations entail a flow of economic resources while the entity is standing ready and, hence, satisfy the probability criterion as articulated in the current IAS 37.
  • A probability recognition criterion is inconsistent with the measurement requirements proposed in the ED because it results in similar obligations being treated very differently. For liabilities that can be measured reliably, the criterion unnecessarily delays including decision-useful information in the balance sheet.
  • Some of the concerns about omitting the probability recognition criterion are concerns about element uncertainty and measurement uncertainty. We are seeking to address these concerns directly. (The Board has already directed the staff to develop more guidance to assist entities in determining when a liability has been incurred. The staff will also be asking the Board to consider what is meant by reliable measurement at a later point in the redeliberations.)

During the debate, Board Members noted that the Board needed to address what was the objective of measurement. Board members were of the view that, at a given measurement date; the objective was to measure the amount of the liability today. It was not to predict the outcome or the amount of the ultimate payment. It was a routine measurement uncertainty issue. Board members also noted the need to address specifically the 'high value, low probability' measurement issue.

Revisiting lawsuits

The Board discussed Examples 1 and 2 included in the Exposure Draft. The Board agreed that:

  • Examples 1 and 2 in the ED are contradictory (and Example 1 was wrong).
  • the illustrative examples accompanying any final Standard need to include additional guidance on how to address 'element uncertainty' in the context of legal proceedings (and similar regulatory actions).
  • the likelihood that an external party will detect an entity's violation of the law or breach of contract is not relevant in determining whether the definition of a liability is satisfied.
  • the start of legal proceedings does not of itself obligate an entity.

The Board noted that detection risk (implicit in Example 2) does not affect the existence of a liability (recognition): it does affect measurement. In addition, it was noted that there was no need for symmetry in accounting between the recognition of a liability by one party and the corresponding asset by another.

With respect to ED Example 1, the Board agreed that the start of legal proceedings does not resolve uncertainty about the facts relating to the claim. They agreed with respondents who noted that start of legal proceedings does not resolve uncertainty about whether the entity served harmful food at a wedding and that this food caused the death of ten guests. At the balance sheet date the entity continues to dispute this fact therefore it is not certain that an obligating event has occurred. In the ED, Example 1 concluded the start of legal proceedings gives rise to a present obligation. This suggests that the start of legal proceedings in itself gives rise to a present obligation (regardless of whether a present obligation exists relating to the subject matter of the lawsuit).

The Board agreed with respondents who argued that determining whether a present obligation exists for the underlying claim should be based on an evaluation of all known evidence. The staff notes that the Framework's definition of a liability states that a present obligation arises from past events (as opposed to a single past event). Thus, the start of legal proceedings is just one of a number of different facts, all of which should be taken into account when determining whether a present obligation exists. This approach is also consistent with the guidance in paragraph 16 of the ED (carried forward from the current IAS 37) which states that an entity must take into account all available evidence when determining whether a liability exists at the balance sheet date.

Correction list for hyphenation

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