PAS 37

Provisions, Contingent
Liabilities and Contingent
Assets
• PAS 37 sets the criteria for recognition and
measurement of
• Provisions;
• Contingent liabilities;
• Contingent assets; and
requires a number of disclosures about these items in
order to understand them better.
• Pas 37 applies to accounting for Provisions, Contingent
Liabilities and Contingent Assets except arising from
executory contracts unless they are onerous and those
that are covered by other PFRS.
• executory contracts – contracts that are not yet fully
executed meaning the parties thereto still have
obligations to perform.
• Onerous – burdensome. When cost of fulfilling it exceeds
the economic benefits to be derived from it.
 What is a provision?
• Provision is a liability of uncertain timing
or amount.
• The word “uncertain” is very important
here, because if timing and amount are
certain or almost certain, then you don’t
deal with the provision but with a
payable or an accrual.
• It is presented in the statement of
financial position separately from other
types of liabilities
• A liability is a present obligation arising from past event that is expected
to be settled by an outflow of economic benefits from an entity.
• In other words, if there is no past event, then there is no liability and no
provision should be recognized.

• Past event can create 2 types of obligation:

• Legal obligation that arises from legislation, a contract or other legal act;
or
• Constructive obligation that arises from some business practice or
customs and created an expectation in other parties to fulfill the obligation
(in other words, people simply expect some company to fulfill the
obligation even if it’s not in the law or any contract).
Examples of provisions
• Warranty Obligations
• Estimated liabilities on pending lawsuits
• Provisions for environmental damage
• Obligation arising from guarantees
• Provisions on onerous contracts
When to recognize a provision?

• The standard IAS sets 3 criteria for recognizing a provision:

• There must be a present obligation as a result of a past event;
• The outflow of economic benefits to satisfy the obligation must
be probable (i.e. more than 50% probable)
• The amount of economic benefits required to satisfy the obligation must
be reliably estimated.

If just one of them is not met, then you should either:

• Disclose a contingent liability (read more about it below), or
• Do nothing if the outflow of economic benefits is remote.
 How to measure a provision?
• The amount of the provision should be measured at the best
estimate of the expenditures required to satisfy the
obligation at the end of the reporting period.
• There are 2 basic methods of measuring a provision:
• Expected value method: You would use this method when
you have a range of possible outcomes or you measure the
provision for large amount of items. In this case, you need to
weight each outcome by its probability (for example,
warranty repair costs for 10 000 products).
• The most likely outcome: This method is suitable in the case
of a single obligation or just 1 item (for example, provision
for loss in the court case).
As you can see, here’s some judgement and estimates involved.
Management should really incorporate all available information in their
estimates and they must not forget about:
• Risks and uncertainties (like inflation),
Estimates may be increased by a Risk Adjustment Factor to
provide an allowance for inherent estimates.
• Time value of money (discounting when the settlement is expected in
the long-term future)
If the effect of time value money is material the estimate is
discounted to its present value
• Some probable future events, etc.
Future events are also considered in estimating only if there is
objective evidence that support its anticipation
• Expected Disposal of Assets.
• Any cash inflow from disposal of asset are treated separately from
measurement of provisions
Nature of the Outflow Measurement Basis

General Rule( e.g. one – off event) Best Estimate

Involves a large population of items Expected Value (probability weighted Average)

Each possible outcome in range is as likely as any Mid point

other
How to account for a provision?

• There are several events associated with the accounting for

provisions:
•
• Recognition of a provision: In most cases, you should recognize a provision in
profit or loss. Sometimes, a provision is recognized in the cost of another
asset, for example, provision for removing the asset and restoring the site
after its use. Don’t forget to split the provision in the current and non-current
part for the presentation purposes in your statement of financial position.
• Unwinding the discount: When a provision has a long-term nature (beyond
12 months), then there’s some discounting involved as you need to present it
in its present value. In each reporting period, you account for an interest on
the opening balance of the provision and this is called „unwinding the
discount“.
• You should recognize the interest in profit or loss and it also increases the
amount of a provision.
• Utilization of a provision: When you incur expenditures associated with
the settlement of your obligation, you should „utilize a provision“.In
most cases, you simply recognize this utilization directly with incurring
the invoices from suppliers or any related payments (e.g. Debit Provision
/ Credit Cash).
• Reimbursement: Sometimes, entities have right to reimbursement of
related expenditures by the third party (e.g. from an insurance
company).In this case, a right to reimbursement is recognized as a
separate asset (no netting off with the provision itself), but you can net
off the expenses for provision with the income from reimbursement in
the profit or loss.
 Provisions in specific circumstances
Future operating losses
• You should not make a provision for future operating loss.
• Because there is no past event. The future operating losses
can be avoided by some future actions, for example – by
selling a business.
• However, you should test your assets for impairment under
IAS 36 Impairment of Assets.
Onerous contracts
• Onerous contract is a contract in which unavoidable costs
of fulfilling exceed the benefits from the contract.
• In other words, it is a loss contract that cannot be avoided.
• You should make a provision in the amount lower of:
• Unavoidable costs of fulfilling the contract and
• Penalty for not meeting your obligations from the contract
• Restructuring
• Restructuring is a plan of management to change the scope of business or a manner
of conducting a business.
• You should recognize a provision for restructuring only when the general criteria for
recognizing provisions are met.
• In the case of restructuring, an obligation to restructure arises only if:
• There is a detailed formal plan for restructuring with relevant information in it
(about business, location, employees, time schedule and expenditures)
• A valid expectation related to restructuring has been raised in the affected parties.
• Examples:
• A. sale or termination of a line of business
• B. closure of the business locations in a country or region or the relocation of
business activities from one country or region to another
• C. changes in management structure, for example, eliminating a layer of
management; and
• D. fundamental reorganizations that have a material effect on the nature and focus
of the entitys operations.
An entity applies the general recognition criteria provided earlier when recognizing provisions
for restructuring costs. In addition, the entity considers the following:
• Sale of operation- a legal obligation exists( and therefore a provision is recognized) only if,
at the end of the reporting period, a binding sale of agreement is obtained. This is because,
until a binding sale agreement is obtained, the entity can still change its mind and may
withdraw its plan to sell if it cannot find a purchaser under acceptable terms.
• Closure or reorganization- a constructive obligation exists( and therefore a provision is
recognized) only if at the reporting date, the entity has created valid expectations from
others that it will discharge that certain responsibilities. This would be the case, if at the
end of the reporting period, both the following conditions are met.
• A. Detailed formal plan for the restructuring is adopted, and
• B. the plan is announced to those affected by it.
• Measurement of restructuring provision
• - a restructuring provision includes only the direct costs that are necessarily
entailed with the restructuring. It does not include cost that relate to the ongoing
activities of the entity or the future conduct of its business. A restructuring
provision excludes the following cost:
• A. Retraining or relocating continuing staff
• B. Marketing
• C. Investment in new systems and distribution networks
Contingent assets
• A contingent asset is a possible asset arising from past events that will be
confirmed by some future events not fully under the entity’s control.
• Similarly as with contingent liabilities, you should not book anything in
relation to contingent assets, but you make appropriate disclosures.
• However, when the realization of income is virtuality certain(100% chance of
occurrence), the asset is not contingent asset and therefore it is appropriate
to recognize it.
contingent probable possible remote
liability Recognize and Disclose only(contingent ignore
disclose(provision) liability)

asset Disclose only(contingent ignore ignore

asset)
Contingent Liabilities
• In general sense all provisions are contingent
A contingent liability is either:
• A possible obligation (not present) from past event that will be
confirmed by some future event; or
• A present obligation from past event, but either:
• The outflow of economic benefits to satisfy this obligation is not
probable (less than 50%), or
• The amount of obligation cannot be reliably measured (this is very rare, in
fact).
• A contingent liability, being a possible obligation, is not recognized
but is disclosed unless the possibility of an outflow of economic
benefits is remote.
 Disclosure
• a) For each class of provision, an entity shall disclose:
• (i) the carrying amount at the beginning and end of the period; (ii)
additional provisions made in the period, including increases to
existing provisions; (iii) amounts used (i.e. incurred and charged
against the provision) during the period; (iv) unused amounts
reversed during the period; and (v) the increase during the period in
the discounted amount arising from the passage of time and the effect
of any change in the discount rate.
•
• (b) Comparative information is not required.
• An entity shall disclose the following for each class of provision:

• 1. nature of the obligation

• 2.the expected timing of any resulting outflows of economic benefits;
• 3. an indication of the uncertainties about the amount or timing of those
outflows.
• 4.major assumptions made concerning future events; and
• 5.the amount of any expected reimbursement, stating the amount of any
asset that has been recognized