Introduction and the Framework


Constructive and legal obligations are specifically defined as follows



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Constructive and legal obligations are specifically defined as follows:

  • Constructive and legal obligations are specifically defined 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 certain responsibilities and
  • (b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities
  • A legal obligation is an obligation that derives from:
  • (a) A contract (through its explicit or implicit terms)
  • (b) Legislation or
  • (c) Other operation of law.
  • An entity should take care to avoid accruing provisions for things that it can
  • avoid through future actions
  • IAS 37 – Recognition

Probable Outflow of Resources Embodying Economic Benefits

  • IAS 37 – Recognition
  • Probable Outflow of Resources Embodying Economic Benefits
  • For recognition, the potential outflow of resources must be probable (more likely than not)
  • If it is not probable, then note disclosure is required, unless the probability is remote
  • Reliable Estimates of an Obligation
  • Provisions, by definition, are very uncertain and therefore may be difficult to measure
  • In general, the standard presumes that the entity should be able to determine a reliable range of outcomes; however, if the provision is not estimable (in rare situations), then note disclosure is required
  • CONTINGENT LIABILITIES AND ASSETS:
  • Note disclosure only, unless the probability of occurrence is remote, in which case note disclosure is not required

BEST ESTIMATE AND RISKS/UNCERTAINTIES:

  • BEST ESTIMATE AND RISKS/UNCERTAINTIES:
  • According to IAS 37, an entity must accrue the best estimate of the amount for the provision
  • Best estimate is defined as follows:
    • The amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time
  • Entities must gather evidence to support the assessment of best estimate, which may require market data and the use of independent experts
  • IAS 37 – Measurement
  • There are differing methodologies for measuring the provision, and the technique chosen depends upon the nature of the item that the provision relates to

PRESENT VALUE:

  • IAS 37 – Measurement
  • PRESENT VALUE:
  • Where the time value is material, the present value of the cash flows must be used in estimating the amount
  • The discount rate shall
    • Be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability
    • Not reflect risks for which future cash flow estimates have been adjusted
  • Since IAS 37 gives little guidance as to how to discount, the following approaches would be acceptable:
  • 1. Adjust the discount rate to reflect the riskiness of the cash flows
  • 2. Use a risk-free rate as the discount rate but consider multiple cash flow scenarios that reflect differing outcomes and their probability of occurrence
      • This method is referred to as the expected present value technique

Either the discount rate or the cash flows are adjusted for risk but not both

  • IAS 37 – Measurement
  • Either the discount rate or the cash flows are adjusted for risk but not both
  • Recall that IAS 37 gives little guidance and thus leaves it to professional judgment

FUTURE EVENTS:

  • IAS 37 – Measurement
  • FUTURE EVENTS:
  • In estimating the provision, entities may consider future events if there is sufficient evidence regarding the occurrence of the events
  • EXPECTED DISPOSAL OF ASSETS:
  • No gains are taken into income for assets that are expected to be sold
    • Since they are not realized

In some cases, some of the cash outflows will be reimbursed

  • IAS 37 – Reimbursements
  • In some cases, some of the cash outflows will be reimbursed
  • This should be assessed separately and recognized when the receipt of cash inflows is virtually certain
  • In terms of presentation, the cost and the reimbursement may be offset in the statement of profit and loss
  • IAS 37 – Changes In and Use of Provisions
  • The provisions should be continually assessed, at a minimum, at the end of each reporting period
  • If the amount of the provision is discounted, then borrowing costs are recognized

FUTURE OPERATING LOSSES:

  • FUTURE OPERATING LOSSES:
  • Future operating losses are not accrued since they represent future events that an entity may be able to get out of
    • However, future losses may be indicative of asset impairment
  • ONEROUS CONTRACTS:
  • According to IAS 37.10, an onerous contract is
  • “. . . a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it”
  • Present obligations under onerous contracts are recognized as provisions in the financial statements
    • Onerous contracts are often purchase commitments, where the entity is locked in and must settle the contract according to terms that are unfavourable to it
  • IAS 37 – Application of the Recognition and Measurement Rules


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