Accounting Standard (AS) 29 Provisions, Contingent Liabilities and Contingent Assets (This Accounting Standard includes p...
Accounting Standard (AS) 29
Provisions, Contingent Liabilities and Contingent Assets
(This
Accounting Standard includes paragraphs set in bold italic type and plain type,
which have equal authority. Paragraphs set in bold italic type indicate the
main principles. This Accounting Standard should be read in the context of its
objective and the General Instructions contained in part A of the Annexure to
the Notification.)
Pursuant to this Accounting Standard coming into effect, all paragraphs
of Accounting Standard (AS) 4, Contingencies and Events Occurring After the
Balance Sheet Date, that deal with contingencies (viz., paragraphs 1 (a), 2,
3.1, 4 (4.1 to 4.4), 5 (5.1 to 5.6), 6, 7 (7.1 to 7.3), 9.1 (relevant portion),
9.2, 10, 11, 12 and 16), stand withdrawn except to the extent they deal with
impairment of assets not covered by other Indian Accounting Standards.
The objective of this Standard is to ensure that
appropriate recognition criteria and measurement bases are applied to
provisions and contingent liabilities and that sufficient information is
disclosed in the notes to the financial statements to enable users to
understand their nature, timing and amount. The objective of this Standard is
also to lay down appropriate accounting for contingent assets.
Scope
1. This
Standard should be applied in accounting for provisions and contingent
liabilities and in dealing with contingent assets, except:
(a) those
resulting from financial instruments9 that are carried at fair value;
(b) those
resulting from executory contracts, except where the contract is onerous;
Explanation :
(i)
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. Thus, for a contract to qualify as an onerous
contract, the unavoidable costs of meeting the obligation under the contract
should exceed the economic benefits expected to be received under it. The
unavoidable costs under a contract reflect the least net cost of exiting from
the contract, which is the lower of the cost of fulfilling it and any
compensation or penalties arising from failure to fulfill it.
(ii) If an
enterprise has a contract that is onerous, the present obligation under the
contract is recognised and measured as a provision as per this Statement.
The
application of the above explanation is illustrated in Illustration 10 of
Illustration C attached to the Standard.
(c) those
arising in insurance enterprises from contracts with policy-holders; and
(d) those
covered by another Accounting Standard.
2.
This
Standard applies to financial instruments (including guarantees) that are not
carried at fair value.
3.
Executory
contracts are contracts under which neither party has performed any of its
obligations or both parties have partially performed their obligations to an
equal extent. This Standard does not apply to executory contracts unless they
are onerous.
4.
This
Standard applies to provisions, contingent liabilities and contingent assets of
insurance enterprises other than those arising from contracts with
policy-holders.
5.
Where another Accounting Standard
deals with a specific type of provision, contingent liability or contingent
asset, an enterprise applies that Standard instead of this Standard. For
example, certain types of provisions are also addressed in Accounting Standards
on:
(a)
construction
contracts (see AS 7, Construction Contracts);
For the purpose of this Standard,
the term ‘financial instruments’ shall have the same meaning as in Accounting
Standard (AS) 20, Earnings Per
Share
(c)
leases
(see AS 19, Leases) . However, as AS 19 contains no specific requirements to
deal with operating leases that have become onerous, this Statement applies to
such cases; and
(d)
retirement
benefits (see AS 15, Accounting for Retirement Benefits in the Financial
Statements of Employers).
6.
Some amounts treated as
provisions may relate to the recognition of revenue, for example where an
enterprise gives guarantees in exchange for a fee. This Standard does not
address the recognition of revenue. AS 9, Revenue Recognition, identifies the
circumstances in which revenue is recognised and provides practical guidance on
the application of the recognition criteria. This Standard does not change the
requirements of AS 9.
7.
This Standard defines provisions as
liabilities which can be measured only by using a substantial degree of
estimation. The term ‘provision’ is also used in the context of items such as
depreciation, impairment of assets and doubtful debts: these are adjustments to
the carrying amounts of assets and are not addressed in this Standard.
8.
Other Accounting Standards
specify whether expenditures are treated as assets or as expenses. These issues
are not addressed in this Standard. Accordingly, this Standard neither
prohibits nor requires capitalisation of the costs recognised when a provision
is made.
9.
This
Standard applies to provisions for restructuring (including discontinuing
operations). Where a restructuring meets the definition of a discontinuing
operation, additional disclosures are required by AS 24, Discontinuing
Operations.
Definitions
10. The following terms are used
in this Standard with the meanings specified:
10.1 A provision
is a liability which can be measured only by using a substantial degree of
estimation.
10.2 A liability
is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.
10.3 An obligating
event is an event that creates an obligation that results in an enterprise
having no realistic alternative to settling that obligation.
10.4 A contingent
liability is:
(a) a
possible obligation that arises from past events and the existence of which
will be confirmed only by the occurrence or non occurrence of one or more
uncertain future events not wholly within the control of the enterprise; or
(b)
a present
obligation that arises from past events but is not recognised because:
(i) it is not
probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
(ii) a
reliable estimate of the amount of the obligation cannot be made.
10.5 A contingent
asset is a possible asset that arises from past events the existence of
which will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the control of the enterprise.
10.6
Present obligation - an obligation is a present obligation if, based on the evidence
available, its existence at the balance sheet date is considered probable,
i.e., more likely than not.
10.7 Possible
obligation - an obligation is a possible obligation if, based
on the evidence available, its existence at the balance sheet date is
considered not probable.
10.8 A restructuring
is a programme that is planned and controlled by management, and materially
changes either:
(a) the scope
of a business undertaken by an enterprise; or
(b) the
manner in which that business is conducted.
11. An obligation is a duty or
responsibility to act or perform in a certain way. Obligations may be legally
enforceable as a
12.
Provisions
can be distinguished from other liabilities such as trade payables and accruals
because in the measurement of provisions substantial degree of estimation is
involved with regard to the future expenditure required in settlement. By
contrast:
(a)
trade payables are liabilities to
pay for goods or services that have been received or supplied and have been
invoiced or formally agreed with the supplier; and
(b)
accruals
are liabilities to pay for goods or services that have been received or
supplied but have not been paid, invoiced or formally agreed with the supplier,
including amounts due to employees. Although it is sometimes necessary to
estimate the amount of accruals, the degree of estimation is generally much
less than that for provisions.
13.
In this
Standard, the term ‘contingent’ is used for liabilities and assets that are not
recognised because their existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the
control of the enterprise. In addition, the term ‘contingent liability’ is used
for liabilities that do not meet the recognition criteria.
Recognition
Provisions
14. A
provision should be recognised when:
(a) an
enterprise has a present obligation as a result of a past event;
(b) it is
probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; and
(c) a
reliable estimate can be made of the amount of the obligation.
If these conditions are not met,
no provision should be recognised.
Present Obligation
15. In almost all cases it will be clear whether a
past event has given rise to a present obligation. In rare cases, for example
in a lawsuit, it may be disputed either whether certain events have occurred or
whether those events result in a present obligation. In such a case, an enterprise
determines whether a present obligation exists at the balance sheet date by
taking account of all available evidence, including, for example, the opinion
of experts. The evidence considered includes any additional evidence provided
by events after the balance sheet date. On the basis of such evidence:
(a)
where it
is more likely than not that a present obligation exists at the balance sheet
date, the enterprise recognises a provision (if the recognition criteria are
met); and
(b)
where it
is more likely that no present obligation exists at the balance sheet date, the
enterprise discloses a contingent liability, unless the possibility of an
outflow of resources embodying economic benefits is remote (see paragraph 68).
Past Event
16.
A past
event that leads to a present obligation is called an obligating event. For an
event to be an obligating event, it is necessary that the enterprise has no
realistic alternative to settling the obligation created by the event.
17.
Financial
statements deal with the financial position of an enterprise at the end of its
reporting period and not its possible position in the future. Therefore, no
provision is recognised for costs that need to be incurred to operate in the
future. The only liabilities recognised in an enterprise’s balance sheet are
those that exist at the balance sheet date.
18.
It is
only those obligations arising from past events existing independently of an
enterprise’s future actions (i.e. the future conduct of its business) that are
recognised as provisions. Examples of such obligations are penalties or
clean-up costs for unlawful environmental damage, both of which would lead to
an outflow of resources embodying
economic benefits in settlement regardless of the
future actions of the enterprise. Similarly, an enterprise recognises a
provision for the decommissioning costs of an oil installation to the extent
that the enterprise is obliged to rectify damage already caused. In contrast,
because of commercial pressures or legal requirements, an enterprise may intend
or need to carry out expenditure to operate in a particular way in the future
(for example, by fitting smoke filters in a certain type of factory). Because
the enterprise can avoid the future expenditure by its future actions, for
example by changing its method of operation, it has no present obligation for
that future expenditure and no provision is recognised.
19.
An
obligation always involves another party to whom the obligation is owed. It is
not necessary, however, to know the identity of the party to whom the obligation
is owed — indeed the obligation may be to the public at large.
20.
An event
that does not give rise to an obligation immediately may do so at a later date,
because of changes in the law. For example, when environmental damage is caused
there may be no obligation to remedy the consequences. However, the causing of
the damage will become an obligating event when a new law requires the existing
damage to be rectified.
21.
Where
details of a proposed new law have yet to be finalised, an obligation arises
only when the legislation is virtually certain to be enacted. Differences in
circumstances surrounding enactment usually make it impossible to specify a
single event that would make the enactment of a law virtually certain. In many
cases it will be impossible to be virtually certain of the enactment of a law
until it is enacted.
Probable Outflow of Resources Embodying Economic Benefits
22. For a liability to qualify for recognition there must be not only a
present obligation but also the probability of an outflow of resources
embodying economic benefits to settle that obligation. For the purpose of this
Standard10 , an outflow of resources or other event is regarded as probable if the
event is more likely than not to occur, i.e., the probability that the event
will occur is greater than the probability that it will not. Where it is not
probable that a present obligation exists, an enterprise
discloses a contingent
liability, unless the possibility of an outflow of resources embodying economic
benefits is remote (see paragraph 68).
23. Where there are a number of similar obligations
(e.g. product warranties or similar contracts) the probability that an outflow
will be required in settlement is determined by considering the class of
obligations as a whole. Although the likelihood of outflow for any one item may
be small, it may well be probable that some outflow of resources will be needed
to settle the class of obligations as a whole. If that is the case, a provision
is recognised (if the other recognition criteria are met).
Reliable Estimate of the Obligation
24.
The use
of estimates is an essential part of the preparation of financial statements
and does not undermine their reliability. This is especially true in the case
of provisions, which by their nature involve a greater degree of estimation
than most other items. Except in extremely rare cases, an enterprise will be
able to determine a range of possible outcomes and can therefore make an
estimate of the obligation that is reliable to use in recognising a provision.
25.
In the extremely rare case where
no reliable estimate can be made, a liability exists that cannot be recognised.
That liability is disclosed as a contingent liability (see paragraph 68).
Contingent Liabilities
26. An
enterprise should not recognise a contingent liability.
27.
A
contingent liability is disclosed, as required by paragraph 68, unless the
possibility of an outflow of resources embodying economic benefits is remote.
28.
Where an
enterprise is jointly and severally liable for an obligation, the part of the
obligation that is expected to be met by other parties is treated as a
contingent liability. The enterprise recognises a provision for the part of the
obligation for which an outflow of resources embodying economic benefits is
probable, except in the extremely rare
10 The interpretation of ‘probable’ in this Standard
as ‘more likely than not’ does not necessarily apply in other Accounting
Standards
29. Contingent liabilities may develop in a way not
initially expected. Therefore, they are assessed continually to determine
whether an outflow of resources embodying economic benefits has become
probable. If it becomes probable that an outflow of future economic benefits
will be required for an item previously dealt with as a contingent liability, a
provision is recognised in accordance with paragraph 14 in the financial
statements of the period in which the change in probability occurs (except in
the extremely rare circumstances where no reliable estimate can be made).
Contingent Assets
30. An
enterprise should not recognise a contingent asset.
31.
Contingent assets usually arise
from unplanned or other unexpected events that give rise to the possibility of
an inflow of economic benefits to the enterprise. An example is a claim that an
enterprise is pursuing through legal processes, where the outcome is uncertain.
32. Contingent
assets are not recognised in financial statements since this may result in the
recognition of income that may never be realised. However, when the realisation
of income is virtually certain, then the related asset is not a contingent
asset and its recognition is appropriate.
33.
A
contingent asset is not disclosed in the financial statements. It is usually
disclosed in the report of the approving authority (Board of Directors in the
case of a company, and, the corresponding approving authority in the case of
any other enterprise), where an inflow of economic benefits is probable.
34.
Contingent
assets are assessed continually and if it has become virtually certain that an
inflow of economic benefits will arise, the asset and the related income are
recognised in the financial statements of the period in which the change
occurs.
Measurement
Best Estimate
35. The
amount recognised as a provision should be the best estimate of the expenditure
required to settle the present obligation at the balance sheet date. The amount
of a provision should not be discounted to its present value except in case of
decommissioning, restoration and similar liabilities that are recognised as
cost of Property, Plant and Equipment. The discount rate (or rates) should 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. The discount rate(s)
should not reflect risks for which future cash flow estimates have been
adjusted. Periodic unwinding of discount should be recognised in the statement
of profit and loss.
36.
The
estimates of outcome and financial effect are determined by the judgment of the
management of the enterprise, supplemented by experience of similar
transactions and, in some cases, reports from independent experts. The evidence
considered includes any additional evidence provided by events after the
balance sheet date.
37.
The
provision is measured before tax; the tax consequences of the provision, and
changes in it, are dealt with under AS 22, Accounting for Taxes on Income.
Risks and Uncertainties
38.
The risks and uncertainties that inevitably surround many events and
circumstances should be taken into account in reaching the best estimate of a
provision.
39.
Risk describes variability of
outcome. A risk adjustment may increase the amount at which a liability is
measured. Caution is needed in making judgments under conditions of
uncertainty, so that income or assets are not overstated and expenses or
liabilities are not understated. However, uncertainty does not justify the
creation of excessive provisions or a deliberate overstatement of liabilities.
For example, if the projected costs of a particularly adverse outcome are
estimated on a prudent basis, that outcome is not then deliberately treated as
more probable than is realistically the case. Care is needed to avoid
duplicating adjustments for risk and uncertainty with consequent overstatement
of a provision.
40.
Disclosure
of the uncertainties surrounding the amount of the expenditure is made under
paragraph 67(b).
Future Events
41. Future
events that may affect the amount required to settle an obligation should be
reflected in the amount of a provision where there is sufficient objective
evidence that they will occur.
42.
Expected
future events may be particularly important in measuring provisions. For
example, an enterprise may believe that the cost of cleaning up a site at the
end of its life will be reduced by future changes
in technology. The amount recognised reflects a reasonable expectation of technically
qualified, objective observers, taking account of all available evidence as to
the technology that will be available at the time of the clean-up. Thus, it is
appropriate to include, for example, expected cost reductions associated with
increased experience in applying existing technology or the expected cost of
applying existing technology to a larger or more complex clean-up operation
than has previously been carried out. However, an enterprise does not
anticipate the development of a completely new technology for cleaning up
unless it is supported by sufficient objective evidence.
43.
The
effect of possible new legislation is taken into consideration in measuring an
existing obligation when sufficient objective evidence exists that the
legislation is virtually certain to be enacted. The variety of circumstances
that arise in practice usually makes it impossible to specify a single event
that will provide sufficient, objective evidence in every case. Evidence is
required both of what legislation will demand and of whether it is virtually
certain to be enacted and implemented in due course. In many cases sufficient
objective evidence will not exist until the new legislation is enacted.
Expected Disposal of Assets
44. Gains
from the expected disposal of assets should not be taken into account in
measuring a provision.
45.
Gains on
the expected disposal of assets are not taken into account in measuring a
provision, even if the expected disposal is closely linked to the event giving
rise to the provision. Instead, an enterprise recognises gains on expected
disposals of assets at the time specified by the Accounting Standard dealing with
the assets concerned.
Reimbursements
46.
Where some or all of the expenditure required to settle a provision is
expected to be reimbursed by another party, the reimbursement should be
recognised when, and only when, it is virtually certain that reimbursement will
be received if the enterprise settles the obligation. The reimbursement should
be treated as a separate asset. The amount recognised for the reimbursement
should not exceed the amount of the provision.
47. In the
statement of profit and loss, the expense relating to a provision may be
presented net of the amount recognised for a reimbursement.
48.
Sometimes,
an enterprise is able to look to another party to pay part or all of the
expenditure required to settle a provision (for example, through insurance contracts,
indemnity clauses or suppliers’ warranties). The other party may either
reimburse amounts paid by the enterprise or pay the amounts directly.
49.
In most
cases, the enterprise will remain liable for the whole of the amount in
question so that the enterprise would have to settle the full amount if the
third party failed to pay for any reason. In this situation, a provision is
recognised for the full amount of the liability, and a separate asset for the
expected reimbursement is recognised when it is virtually certain that
reimbursement will be received if the enterprise settles the liability.
50.
In some
cases, the enterprise will not be liable for the costs in question if the third
party fails to pay. In such a case, the enterprise has no liability for those
costs and they are not included in the provision.
51. As noted in paragraph 28, an obligation for which
an enterprise is jointly and severally liable is a contingent liability to the
extent that it is expected that the obligation will be settled by the other
parties.
Changes in Provisions
52. Provisions should be reviewed
at each balance sheet date and adjusted to reflect the current best estimate.
If it is no longer probable that an outflow of resources embodying economic
benefits will be required to settle the obligation, the provision should be
reversed.
Use of Provisions
53. A provision should be used only for
expenditures for which the provision was originally recognised.
Application of the Recognition and Measurement Rules
Future Operating Losses
55. Provisions
should not be recognised for future operating losses.
56.
Future
operating losses do not meet the definition of a liability in paragraph 10 and
the general recognition criteria set out for provisions in paragraph 14.
57.
An
expectation of future operating losses is an indication that certain assets of
the operation may be impaired. An enterprise tests these assets for impairment
under Accounting Standard (AS) 28, Impairment of Assets.
Restructuring
58. The
following are examples of events that may fall under the definition of
restructuring:
(a)
sale or
termination of a line of business;
(b)
the
closure of 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
re-organisations that have a material effect on the nature and focus of the
enterprise’s operations.
59.
A
provision for restructuring costs is recognised only when the recognition
criteria for provisions set out in paragraph 14 are met.
60. No
obligation arises for the sale of an operation until the enterprise is
committed to the sale, i.e., there is a binding sale agreement.
61.
An enterprise cannot be committed
to the sale until a purchaser has been identified and there is a binding sale
agreement. Until there is a binding sale agreement, the enterprise will be able
to change its mind and indeed will have to take another course of action if a
purchaser cannot be found on acceptable terms. When the sale of an operation is
envisaged as part of a restructuring, the assets of the operation are reviewed
for impairment under Accounting Standard (AS) 28, Impairment of Assets.
62. A
restructuring provision should include only the direct expenditures arising
from the restructuring, which are those that are both:
(a) necessarily
entailed by the restructuring; and
(b) not
associated with the ongoing activities of the enterprise.
63.
A
restructuring provision does not include such costs as:
(a)
retraining
or relocating continuing staff;
(b)
marketing;
or
(c)
investment
in new systems and distribution networks.
These expenditures relate to the
future conduct of the business and are not liabilities for restructuring at the
balance sheet date. Such expenditures are recognised on the same basis as if
they arose independently of a restructuring.
64.
Identifiable
future operating losses up to the date of a restructuring are not included in a
provision.
65.
As
required by paragraph 44, gains on the expected disposal of assets are not
taken into account in measuring a restructuring provision, even if the sale of
assets is envisaged as part of the restructuring.
Disclosure
66. For each
class of provision, an enterprise should disclose:
(a) the
carrying amount at the beginning and end of the period;
(c) amounts
used (i.e. incurred and charged against the provision) during the period; and
(d) unused
amounts reversed during the period.
Provided that a Small and Medium-sized Enterprise (Level II and
Level III non-corporate entities), may not comply with paragraph 66 above.
67. An
enterprise should disclose the following for each class of provision:
(a) a brief
description of the nature of the obligation and the expected timing of any
resulting outflows of economic benefits;
(b) an
indication of the uncertainties about those outflows. Where necessary to
provide adequate information, an enterprise should disclose the major
assumptions made concerning future events, as addressed in paragraph 41; and
(c) the
amount of any expected reimbursement, stating the amount of any asset that has
been recognised for that expected reimbursement.
Provided that a Small and Medium-sized Enterprise (Level II and
Level III non-corporate entities), may not comply with paragraph 67 above.
68.
Unless the possibility of any outflow in settlement is remote, an
enterprise should disclose for each class of contingent liability at the
balance sheet date a brief description of the nature of the contingent
liability and, where practicable:
(a)
an estimate
of its financial effect, measured under paragraphs 35-45;
(b)
an
indication of the uncertainties relating to any outflow; and
(c)
the
possibility of any reimbursement.
69.
In determining which provisions
or contingent liabilities may be aggregated to form a class, it is necessary to
consider whether the nature of the items is sufficiently similar for a single
statement about them to fulfill the requirements of paragraphs 67 (a) and (b)
and 68 (a) and (b). Thus, it may be appropriate to treat as a single class of provision
amounts relating to warranties of different products, but it would not be
appropriate to treat as a single class amounts relating to normal warranties
and amounts that are subject to legal proceedings.
70.
Where a provision and a
contingent liability arise from the same set of circumstances, an enterprise
makes the disclosures required by paragraphs 66-68 in a way that shows the link
between the provision and the contingent liability.
71.
Where any of the information required by paragraph 68 is not disclosed
because it is not practicable to do so, that fact should be stated.
72.
In extremely rare cases, disclosure of some or all of the information
required by paragraphs 66-70 can be expected to prejudice seriously the
position of the enterprise in a dispute with other parties on the subject
matter of the provision or contingent liability. In such cases, an enterprise
need not disclose the information, but should disclose the general nature of
the dispute, together with the fact that, and reason why, the information has
not been disclosed.
Transitional Provisions
73. All the existing provisions for
decommissioning, restoration and similar liabilities (see paragraph 35) should
be discounted prospectively, with the corresponding effect to the related item
of property, plant and equipment.
Illustration
A
Tables -
Provisions, Contingent Liabilities and Reimbursements
The purpose of this illustration is to summarise
the main requirements of the Accounting Standard. It does not form part of the
Accounting Standard and should be read in the context of the full text of the
Accounting Standard.
Provisions and Contingent Liabilities
Where, as a result of past events, there may be an outflow of resources
embodying future economic benefits in settlement of: (a) a present obligation
the one whose existence at the balance sheet date is considered probable; or
(b) a possible obligation the existence of which at the balance sheet date is
considered not probable.
There
is a present obligation
|
There
is a possible obligation
|
There
is a possible
|
|
that
probably requires an
|
or a
present obligation that
|
obligation
or a present
|
|
outflow
of resources and a
|
may,
but probably will not,
|
obligation
where the
|
|
reliable
estimate can be made
|
require
an outflow of
|
likelihood
of an outflow
|
|
of the
amount of obligation.
|
resources.
|
of
resources is remote.
|
|
A
provision is recognised
|
No
provision is recognised
|
No
provision is reco
|
|
(paragraph
14).
|
(paragraph
26).
|
gnised
(paragraph 26).
|
|
Disclosures
are required for the
|
Disclosures
are required for the
|
No
disclosure is required
|
|
provision
(paragraphs 66 and 67)
|
contingent
liability (paragraph 68).
|
(paragraph
68).
|
|
Reimbursements
Some or
all of the expenditure required to settle a provision is expected to be
reimbursed by another party.
The
enterprise has no obligation
|
The
obligation for the amount
|
The
obligation for the amount
|
for the part of the expenditure
|
expected to be reimbursed
|
expected
to be reimbursed
|
to be reimbursed by the
|
remains with the enterprise
|
remains
with the enterprise
|
other party.
|
and it is virtually certain
|
and the
reimbursement is not
|
that reimbursement
|
virtually
certain if the
|
|
will be received if the
|
enterprise
settles the
|
|
enterprise
settles the provision.
|
provision.
|
|
The
enterprise has no liability
|
The
reimbursement is
|
The
expected reimbursement
|
for the amount to be reimbursed
|
recognised as a separate asset in
|
is not
recognised as an asset
|
(paragraph 50).
|
the balance sheet and may be
|
(paragraph 46).
|
offset against the expense in the
|
||
statement of profit and loss. The
|
||
amount recognised for the
|
||
expected reimbursement does
|
||
not exceed the liability
|
||
(paragraphs
46 and 47).
|
||
No
disclosure is required.
|
The
reimbursement is
|
The
expected reimbursement is
|
disclosed together with the
|
disclosed (paragraph 67(c)).
|
|
amount
recognised for the
|
||
reimbursement
(paragraph 67(c)).
|
||
Illustration B
Decision Tree
The
purpose of the decision tree is to summarise the main recognition requirements
of the Accounting Standard for provisions and contingent liabilities. The
decision tree does not form part of the Accounting Standard and should be read
in the context of the full text of the Accounting Standard.
Start
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Present obligation as a
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No
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Possible
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No
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obligation?
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result of an
obligating
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event?
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Yes
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Yes
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No
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Probable outflow?
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Remote?
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Yes
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Yes
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Reliable estimate?
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Yes
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No
(rare)
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Provide
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Disclose contingent
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Do nothing
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liability
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Note: in rare cases, it is not clear whether there is a present
obligation. In these cases, a past event is deemed to give rise to a present
obligation if, taking account of all available evidence, it is more likely than
not that a present obligation exists at the balance sheet date (paragraph 15 of
the Standard).
Illustration C
Illustration: Recognition
This
illustration illustrates the application of the Accounting Standard to assist
in clarifying its meaning. It does not form part of the Accounting Standard.
All the
enterprises in the Illustrations have 31 March year ends. In all cases, it is
assumed that a reliable estimate can be made of any outflows expected. In some
Illustrations the circumstances described may have resulted in impairment of
the assets – this aspect is not dealt with in the examples.
The cross
references provided in the Illustrations indicate paragraphs of the Accounting
Standard that are particularly relevant. The illustration should be read in the
context of the full text of the Accounting Standard.
Illustration 1: Warranties
A manufacturer gives warranties at the time of sale
to purchasers of its product. Under the terms of the contract for sale the
manufacturer undertakes to make good, by repair or replacement, manufacturing
defects that become apparent within three years from the date of sale. On past
experience, it is probable (i.e. more likely than not) that there will be some
claims under the warranties.
Present obligation as a result of
a past obligating event -The obligating event is the sale of the product with a
warranty, which gives rise to an obligation.
An outflow of resources embodying
economic benefits in settlement - Probable for the warranties as a whole (see
paragraph 23).
Conclusion - A provision is recognised for the best estimate of the
costs of making good under the warranty products sold before the balance sheet
date (see paragraphs 14 and 23).
Illustration 2: Contaminated Land -Legislation Virtually Certain to be
Enacted
An enterprise in the oil industry causes
contamination but does not clean up because there is no legislation requiring
cleaning up, and the enterprise has been contaminating land for several years.
At 31 March 2005 it is virtually certain that a law requiring a clean-up of
land already contaminated will be enacted shortly after the year end.
Present obligation as a result of a past obligating
event -The obligating event is the contamination of the land because of the
virtual certainty of legislation requiring cleaning up.
An outflow of resources embodying economic benefits in settlement - Probable.
Conclusion - A provision is recognised for the best estimate of the
costs of the clean-up (see paragraphs 14 and 21).
Illustration 3: Offshore Oil field
An enterprise operates an
offshore oil field where its licensing agreement requires it to remove the oil
rig at the end of production and restore the seabed. Ninety per cent of the
eventual costs relate to the removal of the oil rig and restoration of damage
caused by building it, and ten per cent arise through the extraction of oil. At
the balance sheet date, the rig has been constructed but no oil has been
extracted.
Present obligation as a result of a past obligating
event -The construction of the oil rig creates an obligation under the terms of
the licence to remove the rig and restore the seabed and is thus an obligating
event. At the balance sheet date, however, there is no obligation to rectify
the damage that will be caused by extraction of the oil.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion -A provision is recognised for the best
estimate of ninety per cent of the eventual costs that relate to the removal of
the oil rig and restoration of damage caused by building it (see paragraph 14).
These costs are included as part of the cost of the oil rig. The ten per cent
of costs that arise through the extraction of oil are recognised as a liability
when the oil is extracted.
Illustration 4: Refunds Policy
A retail store has a policy of refunding purchases
by dissatisfied customers, even though it is under no legal obligation to do
so. Its policy of making refunds is generally known.
Present obligation as a result of a past obligating
event -The obligating event is the sale of the product, which gives rise to an
obligation because obligations also arise from normal business practice, custom
and a desire to maintain good business relations or act in an equitable manner.
An outflow of resources embodying economic benefits in settlement
Probable, a proportion of goods are returned for refund (see paragraph
23).
Conclusion - A provision is recognised for the best estimate of the
costs of refunds (see paragraphs 11, 14 and 23).
Illustration 5: Legal Requirement to Fit Smoke Filters
Under new legislation, an
enterprise is required to fit smoke filters to its factories by 30 September
2005. The enterprise has not fitted the smoke filters.
(a) At the
balance sheet date of 31 March 2005
Present obligation as a result of
a past obligating event -There is no obligation because there is no obligating
event either for the costs of fitting smoke filters or for fines under the
legislation.
Conclusion - No provision is recognised for the cost of fitting the
smoke filters (see paragraphs 14 and 16-18).
(b) At the
balance sheet date of 31 March 2006
Present obligation as a result of
a past obligating event -There is still no obligation for the costs of fitting
smoke filters because no obligating event has occurred (the fitting of the
filters). However, an obligation might arise to pay fines or penalties under
the legislation because the obligating event has occurred (the non-compliant
operation of the factory).
An outflow of resources embodying
economic benefits in settlement - Assessment of probability of incurring fines
and penalties by non-compliant operation depends on the details of the
legislation and the stringency of the enforcement regime.
Conclusion - No provision is
recognised for the costs of fitting smoke filters. However, a provision is
recognised for the best estimate of any fines and penalties that are more
likely than not to be imposed (see paragraphs 14 and 16-18).
The government introduces a
number of changes to the income tax system. As a result of these changes, an
enterprise in the financial services sector will need to retrain a large
proportion of its administrative and sales work force in order to ensure
continued compliance with financial services regulation. At the balance sheet
date, no retraining of staff has taken place.
Present obligation as a result of
a past obligating event -There is no obligation because no obligating event
(retraining) has taken place.
Conclusion - No provision is recognised (see paragraphs 14 and 16-18).
Illustration 7: A Single Guarantee
During 2004-05, Enterprise A
gives a guarantee of certain borrowings of Enterprise B, whose financial
condition at that time is sound. During 200506, the financial condition of
Enterprise B deteriorates and at 30 September 2005 Enterprise B goes into
liquidation.
(a) At 31 March 2005
Present obligation as a result of
a past obligating event -The obligating event is the giving of the guarantee,
which gives rise to an obligation.
An outflow of resources embodying economic benefits in settlement
No outflow of benefits is probable at 31 March 2005.
Conclusion -No provision is
recognised (see paragraphs 14 and 22). The guarantee is disclosed as a
contingent liability unless the probability of any outflow is regarded as
remote (see paragraph 68).
(b) At 31 March 2006
Present obligation as a result of
a past obligating event -The obligating event is the giving of the guarantee,
which gives rise to a legal obligation.
An outflow of resources embodying
economic benefits in settlement - At 31 March 2006, it is probable that an
outflow of resources embodying economic benefits will be required to settle the
obligation.
Conclusion -A provision is recognised for the best estimate of the
obligation (see paragraphs 14 and 22).
Note: This example deals with a single guarantee. If an enterprise has a
portfolio of similar guarantees, it will assess that portfolio as a whole in
determining whether an outflow of resources embodying economic benefit is
probable (see paragraph 23). Where an enterprise gives guarantees in exchange
for a fee, revenue is recognised under AS 9, Revenue Recognition.
Illustration 8: A Court Case
After a wedding in 2004-05, ten
people died, possibly as a result of food poisoning from products sold by the
enterprise. Legal proceedings are started seeking damages from the enterprise
but it disputes liability. Up to the date of approval of the financial
statements for the year 31 March 2005, the enterprise’s lawyers advise that it
is probable that the enterprise will not be found liable. However, when the
enterprise prepares the financial statements for the year 31 March 2006, its
lawyers advise that, owing to developments in the case, it is probable that the
enterprise will be found liable.
(a) At 31
March 2005
Present obligation as a result of a past obligating
event -On the basis of the evidence available when the financial statements
were approved, there is no present obligation as a result of past events.
Conclusion - No provision is recognised (see
definition of ‘present obligation’ and paragraph 15). The matter is disclosed
as a contingent liability unless the probability of any outflow is regarded as
remote (paragraph 68).
(b) At 31
March 2006
Present obligation as a result of a past obligating event -On the basis
of the evidence available, there is a present
An outflow of resources embodying economic benefits in settlement - Probable.
Conclusion - A provision is recognised for the best
estimate of the amount to settle the obligation (paragraphs 14-15).
Illustration 9A: Refurbishment Costs -No Legislative Requirement
A furnace has a lining that needs to be replaced
every five years for technical reasons. At the balance sheet date, the lining
has been in use for three years.
Present obligation as a result of a past obligating event -There is no
present obligation.
Conclusion - No provision is recognised (see paragraphs 14 and 16-18).
The cost of replacing the lining is not recognised
because, at the balance sheet date, no obligation to replace the lining exists
independently of the company’s future actions - even the intention to incur the
expenditure depends on the company deciding to continue operating the furnace
or to replace the lining.
Illustration 9B: Refurbishment Costs -Legislative Requirement
An airline is required by law to overhaul its aircraft once every three
years.
Present obligation as a result of a past obligating event -There is no
present obligation.
Conclusion - No provision is recognised (see paragraphs 14 and 16-18).
The costs of overhauling aircraft are not
recognised as a provision for the same reasons as the cost of replacing the
lining is not recognised as a provision in illustration 9A. Even a legal
requirement to overhaul does not make the costs of overhaul a liability, because
no obligation exists to overhaul the aircraft independently of the enterprise’s
future actions - the enterprise could avoid the future expenditure by its
future actions, for example by selling the aircraft.
Illustration 10: An onerous contract
An enterprise operates profitably from a factory
that it has leased under an operating lease. During December 2005 the
enterprise relocates its operations to a new factory. The lease on the old
factory continues for the next four years, it cannot be cancelled and the
factory cannot be re-let to another user.
Present obligation as a result of
a past obligating event -The obligating event occurs when the lease contract
becomes binding on the enterprise, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits
in settlement - When the lease becomes onerous, an outflow of resources
embodying economic benefits is probable. (Until the lease becomes onerous, the
enterprise accounts for the lease under AS 19, Leases).
Conclusion -A provision is recognised for the best estimate of the
unavoidable lease payments.
Illustration D
Illustration: Disclosures
This
illustration does not form part of the Accounting Standard. Its purpose is to
illustrate the application of the Accounting Standard to assist in clarifying
its meaning. An illustration of the disclosures required by paragraph 67 is
provided below.
Illustration 1 Warranties
A manufacturer gives warranties at the time of sale to purchasers of its
three product lines. Under the terms of the warranty, the manufacturer
undertakes to repair or replace items that fail to perform satisfactorily for
two years from the date of sale. At the balance sheet date, a provision of Rs.
60,000 has been recognised. The following information is disclosed:
A provision of Rs. 60,000 has
been recognised for expected warranty claims on products sold during the last
three financial years. It is expected that the majority of this expenditure
will be incurred in the next financial year, and all will be incurred within
two years of the balance sheet date.
An illustration is given below of the disclosures
required by paragraph 72 where some of the information required is not given
because it can be expected to prejudice seriously the position of the enterprise.
Illustration 2 Disclosure Exemption
An enterprise is involved in a dispute with a competitor, who is
alleging that the enterprise has infringed patents and is seeking damages of
Rs. 1000 lakhs. The enterprise recognises a provision for its best estimate of
the obligation, but discloses none of the information required by paragraphs 66
and 67 of the Standard. The following information is disclosed:
Litigation is in process against
the company relating to a dispute with a competitor who alleges that the
company has infringed patents and is seeking damages of Rs. 1000 lakhs. The
information usually required by AS 29, Provisions, Contingent Liabilities and
Contingent Assets is not disclosed on the grounds that it can be expected to
prejudice the interests of the company. The directors are of the opinion that
the claim can be successfully resisted by the company.
This is applicable from 01.04.2017
Amendment in Other accounting standards
Notification
AS 2, Valuation of Inventories
AS 4, Contingencies and Events Occurring After the Balance Sheet Date
AS 10, Property, Plant and Equipment
AS 13, Accounting for Investments
AS 14, Accounting for Amalgamations
AS 21, Consolidated Financial Statements
This is applicable from 01.04.2017
Amendment in Other accounting standards
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