Provisions and contingent liabilities IAS 37 — research project (education session)

Date recorded:

The Technical Manager introduced the session, and noted that this was an Education Session on the research project on Provisions, Contingent Liabilities and Contingent Assets, and that the purpose of the research project was to gather evidence to enable the IASB to make a decision on whether to take on an active project to amend IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and what the scope of such a project should be.  She noted that any project to amend IAS 37 would rely heavily on the Conceptual Framework and because of that, noted that the IASB would need to wait until the revised Conceptual Framework had been finalised before reaching preliminary views on IAS 37.  She noted that the staff wanted to discuss the issue with the IASB at this time for the following reasons:

  1. To give the IASB a chance to offer any suggestions where the staff needed to perform further work before the IASB could reach preliminary views;
  2. To give people thinking of commenting on the Conceptual Framework exposure draft an opportunity to see some of the implications of some of the proposals and how they might be applied by the IASB; and
  3. To help those planning to contribute to the Agenda Consultation in assessing what priority this project should have compared to others.

She asked if the IASB members had any general comments on the project before taking the IASB through the six topics set out in agenda paper 14B.

One IASB member stressed the importance of being clear about the scope of the project, noting the failure of the previous project on this topic was that the IASB members at the time tried to expand the project from a traditional IAS 37 project into a large project on non-financial liabilities, and emphasised the need to confirm the scope to make discussions easier.

Another IASB member noted that in addition to finalising the Conceptual Framework prior to starting on an IAS 37 project, she also believed that the IASB should wait until insurance was finalised because of the crossover, and noted that having insurance finalised would provide an important reference point for thinking about some of the issues about uncertain liabilities.  She also noted that waiting for insurance to be finalised would not have much of an impact from a timing perspective.

She also highlighted that if the IASB was to go ahead with a more limited project on IAS 37 looking at problematic areas, people needed to understand that this did not mean that the IASB could only look at such areas and leave the rest of the Standard unconsidered.  She noted that the IASB still needed to look at the whole Standard to ensure it hung together.  She noted this as a caution for people responding to the Agenda Consultation.

The Technical Manager introduced each topic and asked the IASB members whether they had any questions or comments in relation to each topic.

Topic 1 – Identifying Liabilities

There were no comments by IASB members.

Topic 2 – Recognition Criteria

The Technical Manager highlighted that IAS 37 was unique in that it had three recognition criteria for liabilities, and in particular, it was unusual because it required that it was probable, which is defined as more likely than not that there will be an outflow of resources required to settle the present obligation.  She noted that last time the IASB had looked at IAS 37; the IASB members had raised a concern about the lack of completeness this criterion resulted in, especially when other Standards that were being written at the time did not have the probable outflows criterion.  She further noted that the IASB had proposed to remove it but people strongly objected to this because they felt that the probable outflows criterion was serving a useful purpose in filtering out those liabilities for which the cost of recognition exceeded the benefits.  She further noted that the staff had recently spoken to the Capital Markets Advisory Committee (CMAC) on this issue, and the feedback they had received was that they did not think liabilities should be recognised until outflows were probable. 

An IASB member questioned the reasons CMAC (representing users of financial statements) gave for not wanting the additional information.  The Technical Director responded, noting that CMAC’s feeling was that the amount was very uncertain and there was a need for disclosure anyway, there were some doubts as to whether recognition really added much to the disclosure, and further, they would not want to see a full amount recognised if there was relatively low probability of the outflow.  The Vice-Chairman noted that when he was performing outreach in Australia on this issue, the feedback received was, although it was a blunt tool (either the whole amount is recognised or none), there was a fairly broad acceptance because it was clear and not costly to apply.

There was discussion around differences between the recognition criteria in IAS 37 and US GAAP, with the IASB observing that conceptually the approach to recognising a liability was more or less the same, with the exception of entities defending lawsuits, where ‘probable’ is interpreted under US GAAP as a much higher threshold than the ‘more likely than not’ threshold in IFRS.  Several IASB members suggested the IASB should do some research into whether, even though people interpreted the IFRS and US GAAP guidance having different thresholds, in reality practice was similar, which could mean people were not applying IFRS as they should.  Another IASB member noted that the issue came from the American Bar Association (defence part) who had said that the language in IAS 37 created a lower threshold for the recognition of an obligation, which then potentially prejudiced their clients’ defences in litigation matters, and noted that the threshold was higher in US GAAP so entities did not have to book these obligations.  He pointed out that it did not seem that IFRS reporting entities in the US were having any issues, which could indicate that they were applying more of a US GAAP threshold in that marketplace, and perhaps even internationally.  He also suggested that paragraph 92 of IAS 37 could be trumping recognition thresholds; however, another IASB noted that this exemption (for rare cases when disclosing information would be expected to prejudice seriously the position of the entity in a dispute with another party) only applied to disclosure, not recognition. 

There were concerns expressed about how the staff would go about performing the research into the practice applied by IFRS reporters given it was a very judgmental assessment, and would be difficult to make an assessment unless identical liabilities were being looked at, which would be difficult to achieve given the nature of litigation.  One IASB member pointed out that global banks (domiciled in a number of different jurisdictions) have had major misconduct problems which have resulted in litigation and are all negotiating with the justice department, and suggested the IASB could talk to enough people to get a sense of whether the same threshold was being applied by US GAAP and IFRS reporters. 

The Technical Director noted that he was cautious about going out and talking to people unless the IASB had a clear sense that it might lead somewhere – as it could get people excited for no reason.  An IASB member noted that this was a major focus for the investor community, and it was important for the IASB to know whether its recognition requirements were being overridden by prejudices, and therefore, entities were not recognising liabilities when they should.  Another IASB member noted that from her experience in practice, she had not seen anyone fail to provide information because of commercial prejudice.

Topic 3 – Measurement

With respect to risk adjustments, one IASB member pointed out that the guidance in IAS 37 in this area was old and that it had been discussed in more recent Standards, and suggested that it would make sense to update to reflect the best/most recent thinking if the IASB was to do something on measurement.  He also noted that paragraph 43 of IAS 37 contained a reference to the word “prudence”, which was inconsistent with where the IASB was going in the Conceptual Framework ED, and noted that it was dangerous to allow it to stay there.  He noted that prudence and risk adjustments were completely different things and that they were being confused here.

Another IASB member noted that from an agenda consultation perspective, the IASB should make people aware that there could be a big project on IAS 37, and if the IASB did not move forward with this, there was the potential for a second much narrower project.  She also highlighted the need for the IASB to make it clear that a more limited project could address a group of practical problems that existed which had not been addressed in the past because of a preference to hold off and address the issues as part of a larger project.  She noted that the IASB could use the agenda consultation to gain an understanding of the importance people attached to the IASB undertaking a more limited project if the IASB was going to reject or give low priority to a larger project.

The IASB member noted the importance of making it clear whether the measurement of provisions included or excluded profit margin.  She noted that while insurance was a fulfilment concept, it included a profit margin and so if the IASB were to merely state alignment with the fulfilment notion for IAS 37 liabilities, it could send a confusing message to people.

Another IASB member noted that he believed the concept of risk adjustments was overdone and that best estimates would be a better approach, noting the need for the IASB to make application practical and not overly complex for preparers who did not have access to specialists.

With respect to non-performance risk, a further IASB member noted that he believed the IASB could exclude non-performance risk in general circumstances, but not in extreme circumstances where it would be obvious an entity could not compensate everyone.  He noted the IASB would need to define the scope/cases for when non-performance could be applied.

Topic 4 – Onerous Contracts

There were no comments by IASB members.

Topic 5 – Reimbursement Rights and Contingent Assets

There was discussion around the different thresholds for contingent assets and contingent liabilities, and how this would be impacted by the proposed symmetrical Conceptual Framework definitions of assets and liabilities.  The Technical Manager noted that no one had suggested the threshold for contingent assets should be lowered to be symmetrical with contingent liabilities, and the Technical Director added that it was important to consider the concept of relevance – and whether relevant information would be provided, noting that in the Basis for Conclusions it was not explicit that the IASB proposed either to systematically require symmetry or systematically require asymmetry.  He also noted that with a lot of contingent assets, there was a large degree of existence uncertainty at play as well and emphasised the fact that it was important to look at the individual facts and circumstances.  An IASB member argued that, in theory, having a single principle (i.e. relevance) essentially suggested that one should arrive at a symmetrical outcome, except in situations where unique facts and circumstances existed.  There was discussion around why users found information on contingent assets less relevant than information on contingent liabilities, with one IASB member suggesting that it reflected the fact that investors were going to be more cautious about incorporating upside types of scenarios in their analyses than downside ones.  There was discussion about the reimbursement rights guidance, and the fact that the virtually certain criteria was something that was a problem in practice today.  The Technical Director noted that the guidance on reimbursement rights was written as it was today as it had been inherited from the predecessor to IAS 37.  An IASB member noted that he believed the IASB should strongly consider relaxing the virtually certain criteria for specified events.

Topic 6 – Other Matters: Scope, Terminology And Liability Definition

With respect to scope, one IASB member noted that there was a significant gap in IFRS regarding the disclosure of contractual commitments, noting that it was a very material area of interest for any investor in any company, and that he believed it should be part of the scope.  He observed that in the Conceptual Framework, where the IASB talked about relevance and measurement uncertainty as one of the considerations in determining whether something was capable of making a difference, the IASB had said that there would be situations where disclosure was an important substitute, and noted that there was a nexus between that concept and what the IASB was trying to achieve here.

The IASB member agreed that the terminology section needed some work, and noted specifically that the term “contingent liability” was difficult to understand as an entity either had a liability or it did not.  He noted that an entity could have loss contingencies, but not contingent liabilities – and noted that this should be made clearer.  He also noted that the proposed section in the Conceptual Framework on executory contracts needed a lot more clarity, and noted that the lack of required disclosure of these arrangements was a gaping hole in IFRS.

Another IASB member noted that in the analysis in agenda paper 14C with respect to the Conceptual Framework ED versus IAS 37, the agenda paper appeared to equate “economic compulsion” with “no realistic alternative” and cautioned against viewing the concepts as equivalent.  She noted that if the IASB was to do a project on IAS 37, it might be a good idea to look at how the Conceptual Framework discussion of “no realistic alternative” related to the concept of economic compulsion.


The IASB did not make any decisions at this meeting.

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