IAS 37- PROVISION Vs CONTINGENT LIABILITY

IAS 37- PROVISIONS Vs CONTINGENT LIABILITIES

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            IAS 37 defines Provision as a liability of uncertain timing or amount. Liability itself is defined as a present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits.

IAS 37 excluded some forms of provision from its scope basically because it does not dovetail with the definition of provisions provided by the standard. These provisions include:

i.                    Provision for depreciation: This is not a liability whose timing or amount is uncertain. It is basically the depreciable portion of the cost (gross carrying amount) of an asset systematically allocated over its useful life. It therefore those not entails or demands settlement that requires the outflow of resources embodying economic benefits.

ii.                  Provision for doubtful debt: This is simply an amount set aside for portion of the account receivable the entity projects to become irrecoverable. This therefore leads to a reduction in the economic benefit expected from an asset (account receivable) and those not lead to an outflow of resources embodying economic benefits. It is an expense not a liability.

•  Creditors (trade payables) and accrued expenses are also not considered “provisions”, This is because they do not possess the characteristics of provisions as defined by the standard.

• If all of the above are not provisions aimed at by this standard, then what are those provisions? The provisions within the scope of this standard include the following; so far they didn’t result from executory contracts (except these executory contracts are onerous):  

         a.       Provisions for product warranty;

         b  .     provision for income tax expense;

         c.       Provision by disputed claim by customers;

         d.       Environmental provision;

         e.       Provisions for Restructuring;

         f.        Provision by revenue department of government, etc.

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 Executory contract. A contract under which neither party (to the contract) has performed its     obligations or both the parties (to the contract) have performed their obligations partially to an equal extent.

ž Onerous contract. A contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under the contract.

ACCOUNTING FOR PROVISION

RECOGNITION

Provisions should be recognized if, and only if, all of these conditions are met:

(a) Present Obligation: An entity has a present obligation resulting from a past event;                             

(b) Probability of Outflow of Resources:  It is probable that an outflow of resources embodying economic benefits would be required to settle the obligation; and                                                                                                                                                                                                                          

(c) Reliability of Measurement (Estimate): A reliable estimate can be made of the amount of the obligation.

This means if the above three conditions are met the amount of the estimate (discounted where appropriate) should be incorporated into the statement of financial position and/or statement of comprehensive income.

CONTINGENT LIABILITY

The literal meaning of the word Contingent is “dependent on what may happen" or "possible but not certain”

IAS 37 proffers two definition for the term Contingent liability. It states that:

A contingent liability is:

(a) A possible obligation that arises from past events and whose 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 entity; 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) the amount of the obligation cannot be measured with sufficient reliability.

ACCOUNTING TREATMENT

An entity shall not recognise a contingent liability. A contingent liability is disclosed, as required by paragraph, unless the possibility of an outflow of resources embodying economic benefits is remote.

REASONS FOR ITS NON-RECOGNITION

Recall, the standard states that provisions should be recognised when all three conditions are met. Compare each of the two definitions of contingent liability with the conditions for recognising provisions. It is evident that at least one of the conditions is not met.

For instance, the first definition says “a possible obligation”, this obligation therefore does not currently exist, it is not a “present obligation” as required by provision. Also, the second definition excluded either the second condition or third condition; this therefore those not make contingent liability eligible to be recognised. It should therefore be disclosed.

                                                                                                      

IAS 20- Accounting for Government Grants and Disclosure of Government Assistance

IAS 20 - Accounting for Government Grants and Disclosure of Government Assistance.

Scope

 This Standard shall be applied in accounting for, and in the disclosure of, government grants and in the disclosure of other forms of government assistance.

DEFINITION OF TERMS

Government refers to government, government agencies and similar bodies whether local, national or international.

Government assistance is action by government designed to provide an economic benefit specific to an entity or range of entities qualifying under certain criteria.

Government grants are assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity. They exclude:

          i.            Those  forms of government assistance which cannot reasonably have a value placed upon them (e.g. free technical or marketing advice and the provision of guarantees).  and

        ii.            Transactions with government which cannot be distinguished from the normal trading transactions of the entity (e.g. government procurement policy that is responsible for a portion of the entity’s sales).

Also, Forgivable loans are treated as government grant when there is reasonable assurance that the entity will meet the terms for forgiveness of the loan

Forgivable loans are loans which the lender undertakes to waive repayment of under certain prescribed conditions.

TYPES OF GOVERNMENT GRANTS

1)       GRANTS RELATED TO ASSETS: are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term assets.

2)      GRANTS RELATED TO INCOME: are government grants other than those related to assets. Also, It includes a grant receivable as compensation for costs, either:

• —   Already incurred

• —   For immediate financial support, with no future related costs.

RECOGNITION OF GOVERNMENT GRANTS

a) Government grants, including non-monetary grants at fair value, shall not be recognised until there is reasonable assurance that:       

—  i.  the entity will comply with the conditions attaching to them; and

— ii.  the grants will be received.    

b) A forgivable loan from government is treated as a government grant when there is reasonable assurance that the entity will meet the terms for forgiveness of the loan.

ACCOUNTING FOR GOVERNMENT GRANTS

APPROACHES

There are two broad approaches to the accounting for government grants:

1)      The capital approach, under which a grant is recognised outside profit or loss, and

2)       The income approach, under which a grant is recognised in profit or loss over one or more periods.

ARGUMENTS IN SUPPORT OF EACH APPROACH

A.       CAPITAL APPROACH: Those in support of the capital approach argue as follows:

—  Purpose: Financing device, government grants are a financing device.

—  Unearned income: they are not earned but represent an incentive provided by government without related costs.

B.       INCOME APPROACH: Arguments in support of the income approach are as follows:

—  Source: government grants are receipts from a source other than shareholders

—  Earned income: government grants are rarely gratuitous; the entity earns them through compliance with their conditions and meeting the envisaged obligations.

—  Extension of Fiscal Policy: because income and other taxes are expenses, it is logical to deal also with government grants, which are an extension of fiscal policies, in profit or loss.

ACCEPTED APPROACH

The INCOME approach, which states that, Government grants shall be recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate.

       A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognised in profit or loss of the period in which it becomes receivable.

NON-MONETARY GRANTS

Non-monetary grants, such as land or other resources, are usually accounted for at

ü Fair value, {the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.}

ü Nominal amount (alternative treatment), {a minimal price fixed for the sake of having some consideration for a transaction. It need bear no relation to the market value of the item.}

PRESENTATION OF GRANTS RELATED TO ASSET

Presentation in the Statement of Financial Position

        - Methods of presentation: Government grants related to assets, including nonmonetary grants at fair value, should be presented in the statement of financial position in either of two ways:

        i.            Deferred income approach: under this method, the grant is set up as deferred income.

      ii.            Asset’s Net Carrying amount approach: Under this method, the value of the grant is deducted from the cost (gross carrying amount) of the asset that the grant is financing. The asset is then recognised at the net carrying amount (Cost minus grant) from the inception. 

 

ACCEPTABLE METHOD(s)

      The Two methods of presentation in financial statements of grants related to assets are regarded as acceptable alternatives.

PRESENTATION OF GRANTS RELATED TO INCOME

Methods of presentation:

1.       SEPARATE PRESENTATION, where grant is presented as a credit in the statement of comprehensive income, either separately or under a general heading such as ‘Other income’

2.       OFFSET BASIS, where grant are deducted in reporting the related expense.

   -Acceptable method(s)

 Both methods are acceptable

REPAYMENT OF GOVERNMENT GRANT

Repayment? Why should Government be repaid? Recall, the definition of Government grant attached to itself  "compliance with certain conditions". If those future conditions are not met, this may warrant the repayment of the grants
A government grant that becomes repayable shall be accounted for as a change in accounting estimate.

GRANT RELATED TO INCOME                                                                                                      

 •Repayment of a grant related to income shall be applied first against any unamortised deferred credit recognised in respect of the grant.

•To the extent that the repayment exceeds any such deferred credit, or when no deferred credit exists, the repayment shall be recognised immediately in the profit or loss.                                                                                                        

GRANT RELATED TO ASSET   

 •Repayment of a grant related to an asset shall be recognised by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable.

•The cumulative additional depreciation that would have been recognised in profit or loss to date in the absence of the grant shall be recognised immediately in profit or loss.

GOVERNMENT ASSISTANCE

Some forms of government assistance are excluded from the definition of government grants.

(a) Some forms of government assistance cannot reasonably have a value placed on them, e.g. free technical or marketing advice, provision of guarantees.

(b) There are transactions with government which cannot be distinguished from the entity's normal trading transactions, e.g. government procurement policy resulting in a portion of the entity's sales.

Disclosure of such assistance may be necessary because of its significance; its nature, extent and duration should be disclosed

                                                                 DISCLOSURES

The following matters shall be disclosed:

(a) the accounting policy adopted for government grants, including the methods of presentation adopted in the financial statements;

(b) the nature and extent of government grants recognised in the financial statements and an indication of other forms of government assistance from which the entity has directly benefited; and

(c) unfulfilled conditions and other contingencies attaching to government assistance that has been recognised.

International Accounting Standard 2- Inventories

 International Accounting Standard 2- Inventories

The International Financial Reporting Standard IAS 2- INVENTORY prescribes the accounting treatment for inventory.

This Standard provides guidance on:

• ·         the determination of cost and its subsequent recognition as an expense,

• ·        Any write-down to net realisable value, as well as reversal of this write-down

• ·          It also provides guidance on the cost formulas that are used to assign costs to inventories.

Inventories are assets:

(           (a)    held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

This therefore means, Inventories are assets held by and entity, whether by virtue of purchase or production, or in the process of production in which the entity intends to sell in its normal course of business. Thus, Motor van acquired by a Manufacturing company, with the intention of using it to distribute goods is not an inventory, whereas  a motor van purchased by a Motor dealer whose purpose is to resell the van in its ordinary course of business will be classified as inventory.

Succinctly, Inventory includes:

·         Finished Goods

·         Work-in-progress

·         Raw materials and

·         Consumable supplies

In the case of a service provider, inventories include the costs of the service, for which the entity has not yet recognised the related revenue.

MEASUREMENT OF INVENTORY

Inventories shall be measured at the lower of cost and net realisable value.

COST OF INVENTORY

The cost of inventories shall comprise all:

 costs of purchase,                                                           X

costs of conversion and                                                     X

other costs                                                                      X

                                                                                       X

 

The above costs must be those incurred in bringing the inventories to their present location and condition.

NET REALISABLE VALUE

This is the estimated selling price in the ordinary course of business less the estimated

costs of completion and the estimated costs necessary to make the sale.

Estimated Selling price                                         X

Estimated Cost to complete (if applicable)             (x)

Estimated cost to sell                                           (x)

                                                                           X

Note, Net realisable value is not the same as Fair value. NRV is an entity-specific value, while Fair value is a market-based valuation. Net realisable value for inventories may not equal fair value less costs to sell.

JUSTIFICATION FOR THE MEASUREMENT

·         When Cost is higher than NRV: The practice of writing inventories down below cost to net realisable value is consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or use.

·         When NRV is higher than Cost: The practice of not writing inventory above cost is probably to observe the prudence principle.

The cost of inventories may not be recoverable if:

1.       those inventories are damaged;

2.       if they have become wholly or partially obsolete;

3.       if their selling prices have declined;

4.       if the estimated costs of completion have increased; or

5.       the estimated costs to be incurred to make the sale have increased.

Techniques for the measurement of cost 

The cost of inventory can be approximately arrived at using the following techniques:

a.       Standard cost method: Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation.

b.      Retail method: The cost of the inventory is determined by reducing the sales value of the inventory by the appropriate percentage gross margin.

COST FORMULA

These are formulas that are used to assign cost to inventory.  It facilitates the assignment of cost in determining Cost of sales of inventory, Cost of closing inventory, etc.

A.      When the Inventories are not Ordinarily Interchangeable: The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.

·         Not Ordinarily Interchangeable: This is not remote, it means the items of inventory are heterogeneous; they are not looking similar or perfectly similar.

·         Specific Identification: Specific identification of cost means that specific costs are attributed to identified items of inventory.

B.      When the Inventories are not Ordinarily Interchangeable: The cost of inventories, other than those dealt with in A above, shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula.

·         Ordinarily Interchangeable: This means the items of inventory are homogeneous, one can easily or perfectly replace the other.

N:B Last-in, last-out cost (LIFO) formula is not permitted by IAS 2.

RECOGNITION AS AN EXPENSE

·         When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised.

·         The amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs.

·         The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories  recognised as an expense in the period in which the reversal occurs.