IAS 37 Provisions, Contingent Assets and Contingent Liabilities

IAS 37
PROVISIONS, CONTINGENT
ASSETS AND CONTINGENT
LIABILITIES
1
Introduction
IAS 37
Contingent
Provisions
liabilities
Contingent
assets
Recognition Measurement Disclosure
2 IAS 37 Provisions, contingent assets and contingent liabilities

Scope
Provisions against assets:
 Provision for bad debt
 Provision for accumulated depreciation
 Provision for obsolete inventory
Adjustments against the carrying amount of

asset provision (accumulated
depreciation/impairment loss)

Provisions
A provision is a liability with uncertain

timing or amount
Different from trade payables and accruals

What is the difference
between an accrual and
trade payables?

All 3
Provision - Recognition
bullets!!
• An entity has a present obligation (legal or

constructive) as a result of a past event and
• It is probable that an outflow of resources
embodying economic benefits will be
required to settle the obligation and
• A reliable estimate can be made of the
amount of the provision

Present obligation
Legal Constructive
Arises from Arises from - Contract;
entity’s actions
legislation;
Other operations
of law

Constructive obligation:
Derives from an entity’s actions where:
• By an established pattern of past practices,
published policies or a sufficiently specific current
statement the entity has indicated to other parties
that it will accept certain responsibilities and
• As a result the entity has created a valid expectation
on the part of those other parties that it will
discharge those responsibilities

Provision –
Recognition
An entity has a present obligation
More likely than not

Provision –
Recognition
As a result of a past event
Past event that gives rise to present obligation =

Obligation event = no realistic alternative but to
settle the obligation
 Commitment to another party

Provision –
Recognition
It is probable that an outflow of resources
embodying economic benefits will be required
to settle the obligation
more likely
than not

Example
X Ltd provided a one-year guarantee on all its
products, ito which products with defects will either be
repaired or replaced. Past experience indicates that it
is probable (i.e. more likely than not) that there will be
some claims under the guarantees and its estimated
that that cost of repairs or replacements will amount
to R50 000.
Ex 22.1

Example
• Present obligation as a result of a past event →
• sale of product with a guarantee = legal obligation
• Outflow of economic resources →
• based on past experience it is probable
• Amount estimated reliability →
• R50 000
 A provision of R50 000 is recognised

Example
An entity operates an offshore oilfield, ito its licensing
agreement, the entity has to remove the oilrig at the
end of the production and restore the seabed. It is
estimated that 90% of the removal and the restoration
cost relates to the restoration of damage caused by
erecting the oilrig, while 10% arises due to the
extraction of the oil. @ YE no oil has been extracted.
Estimated removal and restoration cost = R500 000 (PV
= R350 000)
Ex 22.2

Example
construction of the oilrig = legal obligation
licensing agreement compels the entity to incur
restoration cost
R350 000 (NB!! Present value!!)

Example
@ YE no obligation to rectify the damaged that will be
caused by extraction of oil, as extraction has not yet
commenced. Thus no past event, no damage
 A provision of 90% of R350 000 is recognised =

R315 000

Example
X Ltd sells jewelry. It is generally known that the
company refunds purchases made by dissatisfied
customers, even though it is under no legal obligation
to do so. Past experience indicates that it is probable
(i.e. more likely than not) that there will be some
returns and it is estimated that the cost of the refunds
will amount to R20 000 based on historical
information.
Ex 22.3

Example
• sale of jewelry = constructive obligation because
created a valid expectation that store will refund
purchases
• past experience indicates that a portion of goods are
returned for a refund
• R20 000

Contingent liabilities
• A possible obligation that arised from a
past event
• And whose existence will be confirmed
only by the occurrence or non-
occurrence of one of more uncertain
future events not wholly within the
entity’s control
• OR
• A present obligation that arises from a past
event
• But is NOT recognised because….
• It is not probable that an outflow of resources
embodying economic benefits will be
required to settle the obligation or
• The amount of the obligation cannot be
measured with sufficient reliability

Contingent liability is NOT recognised
(meaning to put a Rand amount in the SFP)
BUT… (isn’t there just always a but…..)
Disclosed in notes to the AFS

Unless possibility of an outflow of resources embodying
economic benefits is remote

Probability of outflow of resources may change
→ assessed continually
Contingent liability → Provision

Contingent liability → Nothing
Provision
Obligation
Contingent liability

Example
A Ltd terminated the employment of one of its
employees during 2015, who sued A Ltd for unfair
dismissal 2 months later. A Ltd decided not to settle,
but contest the case.
A Ltd lawyer advised @ 2015 FY-end that entity would

probable NOT be found liable.
@ 2016 FY-end lawyer indicated will probably be found

liable
Ex 22.4

Example
2015 FY
• dismissal of employee = legal obligation ito labour
legislation
• not probable as legal opinions indicated that entity
probably will not be found guilty
• Amount estimated reliability → ?
 A provision is NOT recognised

Example
2016 FY
• dismissal of employee = legal obligation ito labour
legislation
• probable as legal opinions indicated that entity
probably will be found guilty
• Best estimate of amount to settle the obligation
 A provision is recognised

Contingent asset
• A possible asset that arises from a past
event
• And whose existence will be confirmed
only by the occurrence or non-occurence
of one of more uncertain future events
not wholly within the entity’s control

Contingent asset
Contingent asset is NOT recognised (meaning
to put a Rand amount in the SFP)
BUT… (isn’t there just always a but…..)
Disclosed in notes to the AFS

If inflow of economic benefits is probable

Contingent asset
Probability of inflow of resources may change
→ assessed continually
Contingent asset → Asset

Violation of
a law
Example
B Ltd sued C Ltd on 30 November for an infringement
of a trademark. On 15 December the lawyer of C Ltd
approached B Ltd and proposed a settlement of R700
000. B Ltd rejected the settlement offer as its attorneys
expect the court to award at least R2million. Year end =
December
Ex 22.5

Example
Outcome uncertain:
B Ltd does not recognise an asset, but disclose a
contingent asset if inflow of economic benefits is
probable
Outcome virtually certain:

Dr. Asset R??
Cr. Income Best estimate to be
received @ YE

Measurement
Estimate of expenditure
Apply judgement
Experience of similar transactions and reports from

independent experts
NB!
Events after the reporting date should be taken into

account!
Example
An entity provides a one-year guarantee on all
products sold ito which the entity covers the cost of
repairs of any defects that become apparent within the
first year after purchase.
Minor defects = R3 million
Major defects = R8 million Cost of repair:
Past experience indicates: (70% x R0) + (24% x
No defects = 70% R3m) + (6% x R8m)
Minor defects = 24% =
R1 200 000
Major defects = 6%
Ex 22.6
Risks and uncertainties
Over stating liability

vs
Under stating liability
Dr. Expense (P/L)

Cr. Provision (SFP)
Higher risk Higher estimate

Present value
Provision = Present value of expenditure that will

be incurred in future
Before tax!
Discount rate = Pre-tax rate
How do you go from a after

tax rate to pre-tax rate???
After tax %
x 100 / 100 – tax %

Present value
Example:
After tax %
x 100 / 100 – tax %
After tax discount % = 18%
Tax rate = 28%
Pre-tax discount % = 18% x 100/72

= 25%
Example
X Ltd installed machinery in a leased factory building at
begin of year. Ito lease agreement the machinery
should be dismantled at the end of year 10 (when
lease agreement ends). It is expected that the cost to
dismantle the machinery will amount to R50 000. A fair
discount rate of 14% after tax and current tax rate =
30%.
Ex 22.7

Example
installation of machine present legal obligation ito
lease contract
• Outflow of economic resources → probable per
lease agreement
• Amount estimated reliability → R50 000
A provision is recognised
How much???
FV = R50 000 Pre-tax
discount
N = 10 rate!
I/Yr = 20% (14%/70%)
PV = R8 075
Future events
Affecting the amount of provision raised
Only take into account if there is sufficient

objective evidence that they will occur
Insufficient evidence that future evidence will

occur → measure without taking into account
effect thereof

Future events
Future event do materialise → CA of provision
revised
Difference = P/L

Expected disposal of assets
Disposal of asset linked to recognition of provision

For example restructure operations
Gains from disposal NOT taken into account when

measuring the provision

Reimbursement rights
Provision raised – expense reimbursed by another

party
Reimbursement right = Asset ONLY when virtually

certain reimbursement will be received
DO NOT net reimbursement asset off against the

provision liability Entity remains liable if
3rd part fails to pay

Reimbursement rights
In profit and loss → expense of provision can be

net of  gain recognised for reimbursement right
Reimbursement right (asset) may never ever >

Provision!!
If entity not liable for cost if 3rd party fails to pay =

No provision or asset

Example
X Ltd provides a 6 month guarantee on all it products
ito which it will repair products with manufacturing
defects free of charge. An agreement between X Ltd
and its supplier entitles X Ltd to recoup 75% of repair
costs incurred from the supplier. From past experience
it is estimated that repair cost of R80 000 will be
incurred after year end iro goods sold during the
financial year. The time value of money ncm.
Ex 22.8

Example
At year end X Ltd raise a provision of R80 000 for
expected future repair costs.
Simultaneously an asset (reimbursement right) of R60

000 (R80 000 x 75%) should be recognised for the
recoupment of repair cost from supplier.
Asset and provision netted off in SFP

However…. In Profit and loss:
R20 000 (R80 000 – R60 000)

Changes in provisions
Reviewed at each reporting period
Outflow of economic benefits no longer probable

→ reverse provision
Provision @ PV will increase every year due to

passing of time, i.e. finance cost

Use of provisions
Only used for purpose raised and any unused

amount should be reversed to profit and loss

Future operating losses
Present obligation
of entity @ YE
 NOT a provision
IAS 37 prohibits providing for future losses
Future losses → indication of

impairment of assets

Onerous contracts
Contract in which the unavoidable costs of

meeting the obligations under the contract exceed
the economic benefits expected to be received
under it
Present obligation under the contract should be

recognised as a provision

Onerous contracts
Raise a provision @ lower of:

❖the cost to the entity to fulfil its contractual
obligations
❖any compensation or penalties that would be
payable should the entity fail to fulfil its
contractual obligations

Example
An entity has an agreement to provide 500 000 pairs of
to a once-off customer at a fixed price over 2
years. At the end of the 1st year, after providing 150
000 pairs of to the customer, the price of the
raw materials used increased unexpectedly. The entity
was unable to renegotiate the sales price with its
customer and would have to pay a penalty of R500 000
if it cancels the contract.
Ex 22.9

Example
It is expected that the remaining pairs of shoes will
be delivered 12 months after the reporting date for a
total of R3.5million. The total cost of producing the
measured at the same point in time is expected to be
R4.1million. Assume a discount rate of 10% per annum
before tax.

Example
• signing of contract = legal obligation
• probable, onerous contract
•Present value of expected cost = R545 455
FV = 600 000
N =1
I/Yr = 10

Onerous contracts
Raise a provision @ lower of:

❖the cost to the entity to fulfil its contractual
obligations = R545 455
❖any compensation or penalties that would be
payable should the entity fail to fulfil its
contractual obligations = R500 000

Restructuring
Change the scope of the business or the manner in which
business is conducted
Constructive obligation only arises when:

 has a detailed formal plan for restructuring that identifies at
a minimum:
➢ business or part of business concerned
➢ The principal location affected
➢ The location, function and approximate number of
employees that will be compensated for terminating services
➢ The expenditure that will be undertaken
➢ When the plan will be implemented

Restructuring
 Has raised a valid expectation in those affected that will carry
out the restructuring by starting to implement the plan or
announcing its main features to those affected by it
If the expectation only raised after YE → Non-adjusting event

Restructuring
• Provision should only include DIRECT EXPENDITURE
arising from the restructuring, which are those that
are both
- necessary entailed by the restructuring
- Not associated with the on-going activities of the
entity
- Example: Penalties payable to cancellation of lease
contracts

Restructuring
Cost relating to retraining or relocating continuing

staff, marketing or investment in new systems and
distribution networks are NOT included in
restructuring provision →
Future cost to conduct business and not present
obligation due to restructure

IFRIC 5, IFRIC 6, IFRIC 21

Change in discount rate
T Ltd has a dismantling provision for which the time
value of money is material. During the financial year
ended 30 June 2003 the company determined the
present value of the provision using a pre-tax discount
rate of 10% p.a. On 30 June 2004 the company
determines an appropriate pre-tax discount rate is now
12% p.a. It is the company’s policy to account for the
effect of changes in the discount rate at the start of the
reporting period.
Ex
22.12

The impact of change in discount rate on CA of
provision:
Current rate New rate
FV = R2 000 000 R2 000 000
N = 10 10
I/Yr = 10% 12%
PV = R771 087 R643 946
Decrease in PV of provision due to change in discount

rate = R127 141 (R771 087 – R643 946)

Interest cost =
R643 946 x 12% = R77 274
Balance of provision = R721 220 (R643 946 + R77 274)

Presentation
Face of SFP
Non-current OR current liabilities
You will have to decide,

depending on the payment
terms

Disclosure
Provisions Decommission cost Warranties Total
R R R
Carrying amount at the xxx xxx xxx
beginning of the year
Change in provision due to xxx or (xxx) xxx or (xxx) xxx or
change in discount rate (xxx)
Additional provision raised xxx xxx xxx
during year
Amount used during year (xxx) (xxx) (xxx)
Unused amounts reversed (xxx) (xxx) (xxx)
during year
Finance cost xxx xxx xxx
Carrying amount at end of the xxx xxx xxx
year

Disclosure - Provision
✓ Brief description of nature of obligation and

expected timing of outflow of economic benefits
✓ Indication of uncertainty about amount/timing –
major assumptions made
✓ Amount of expected reimbursement

Disclosure –
Contingent liability
For each class of contingent liability:
✓ Brief description of nature of contingent liability
✓ Estimate of its financial effect
✓ Indication of uncertainties about timing/amount
✓ Possibility of reimbursement

Disclosure – Contingent asset
For each class of contingent asset:

✓ Brief description of contingent asset
✓ Estimate of its financial effect

Disclosure
If info required is NOT disclosed because it is not
practicable to do so:
✓ Fact should be stated
If the information can seriously prejudice the

position of entity in a dispute → need not to
disclose the information , but…
Disclose general nature of dispute, together with
fact that and reason why info cannot be disclosed

Disclosure
Example
 page 786-787

TB for liability = CA – amount
Taxation deductible for tax purposes in future
Expense may be deducted for TB = CA

tax purposes when provision Thus NO TD
raised Thus NO DT!!
Expense may be deducted for TB = 0
tax purposes when amount is CA = xxx
settled in future Thus TD
Thus DT!!
Expense may NOT be TB = CA
deducted for tax purposes at Thus NO TD
any stage Thus NO DT!!

Summary
✓ Page 788

HOMEWORK!!
✓ 37.1
✓ 37.5


IAS 37 Provisions, Contingent Assets and Contingent Liabilities

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IAS 37 Provisions, Contingent Assets and Contingent Liabilities

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IAS 37

Recognition Measurement Disclosure

2 IAS 37 Provisions, contingent assets and contingent liabilities

Adjustments against the carrying amount of

3 IAS 37 Provisions, contingent assets and contingent liabilities

A provision is a liability with uncertain

Different from trade payables and accruals

4 IAS 37 Provisions, contingent assets and contingent liabilities

• An entity has a present obligation (legal or

5 IAS 37 Provisions, contingent assets and contingent liabilities

6 IAS 37 Provisions, contingent assets and contingent liabilities

7 IAS 37 Provisions, contingent assets and contingent liabilities

More likely than not

8 IAS 37 Provisions, contingent assets and contingent liabilities

Past event that gives rise to present obligation =

9 IAS 37 Provisions, contingent assets and contingent liabilities

10 IAS 37 Provisions, contingent assets and contingent liabilities

11 IAS 37 Provisions, contingent assets and contingent liabilities

 A provision of R50 000 is recognised

12 IAS 37 Provisions, contingent assets and contingent liabilities

13 IAS 37 Provisions, contingent assets and contingent liabilities

14 IAS 37 Provisions, contingent assets and contingent liabilities

 A provision of 90% of R350 000 is recognised =

15 IAS 37 Provisions, contingent assets and contingent liabilities

16 IAS 37 Provisions, contingent assets and contingent liabilities

17 IAS 37 Provisions, contingent assets and contingent liabilities

19 IAS 37 Provisions, contingent assets and contingent liabilities

BUT… (isn’t there just always a but…..)

Disclosed in notes to the AFS

20 IAS 37 Provisions, contingent assets and contingent liabilities

Contingent liability → Provision

21 IAS 37 Provisions, contingent assets and contingent liabilities

A Ltd lawyer advised @ 2015 FY-end that entity would

@ 2016 FY-end lawyer indicated will probably be found

22 IAS 37 Provisions, contingent assets and contingent liabilities

23 IAS 37 Provisions, contingent assets and contingent liabilities

24 IAS 37 Provisions, contingent assets and contingent liabilities

25 IAS 37 Provisions, contingent assets and contingent liabilities

BUT… (isn’t there just always a but…..)

Disclosed in notes to the AFS

26 IAS 37 Provisions, contingent assets and contingent liabilities

Contingent asset → Asset

27 IAS 37 Provisions, contingent assets and contingent liabilities

28 IAS 37 Provisions, contingent assets and contingent liabilities

Outcome virtually certain:

29 IAS 37 Provisions, contingent assets and contingent liabilities

Experience of similar transactions and reports from

Events after the reporting date should be taken into

Over stating liability

Dr. Expense (P/L)

Higher risk Higher estimate

Provision = Present value of expenditure that will

Discount rate = Pre-tax rate

How do you go from a after

33 IAS 37 Provisions, contingent assets and contingent liabilities

Tax rate = 28%

Pre-tax discount % = 18% x 100/72

35 IAS 37 Provisions, contingent assets and contingent liabilities

Only take into account if there is sufficient

Insufficient evidence that future evidence will

37 IAS 37 Provisions, contingent assets and contingent liabilities

38 IAS 37 Provisions, contingent assets and contingent liabilities