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.