Ind as 37, provisions, contingent liabilities and contingent assets

IV Semester M.Com

1. Provisions , Contingent Liabilities and Contingent Assets Ind AS – 37 Mr. Sathish V Assistant Professor PES Institute of Advanced Management Studies NH-206, Sagar Road Shivamogga

2. Objective The objective of this Standard is to ensure that, Appropriate recognition criteria and measurement bases are applied to Provisions, Contingent Liabilities and Contingent Assets and that, Sufficient information is disclosed in the Notes to enable users to understand their nature, timing and amount.

3. Scope This Standard shall be applied by all entities in accounting for Provisions, Contingent Liabilities and Contingent Assets, except, Those resulting from executory contracts ( a contract under which both sides still have important performance remaining ), except where the contract is onerous (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); and Those covered by another Standard. 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 .

4. Definitions A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A provision is a liability of uncertain timing or amount. An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. (a) A legal obligation is an obligation that derives from (a) a contract (through its explicit or implicit terms); (b) legislation; or (c) other operation of law. (b) A constructive obligation is an obligation that derives from an entity’s actions where (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and (b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.  

5. Definitions (contd) A contingent liability is, 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 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. A contingent asset is a possible asset 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 .

6. Provisions and Other Liabilities Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement of Provisions. By contrast: 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 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.

7. Provisions Vs Contingent Liabilities In a general sense, all provisions are contingent because they are uncertain in timing or amount. Provisions are recognised as liabilities (assuming that a reliable estimate can be made) because they are present obligations and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations. However, within 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 entity .

8. Recognition

9. Recognition (contd) Provisions: A provision shall be recognised when, an entity has a present obligation (legal or constructive) as a result of a past event; 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 obligation. If these conditions are not met, no provision shall be recognised .

10. Recognition (contd) Contingent Liabilities : An entity shall not recognise a contingent liability. A contingent liability is disclosed. Contingent Assets: An entity shall not recognise a contingent asset. Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the entity. An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain.

11. Measurement

12. Measurement (contd) Best Estimate : The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Risks and Uncertainties : The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision. Risk describes variability of outcome. However, u ncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities. Present Value : Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation. Future Events : Future events that may affect the amount required to settle an obligation shall be reflected in the amount of a provision where there is sufficient objective evidence that they will occur. Expected Gain on disposal of Assets : Gains from the expected disposal of assets shall not be taken into account in measuring a provision.

13. Reimbursements Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognised for the reimbursement shall not exceed the amount of the provision. In the statement of profit and loss, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.

14. Changes in Provisions Provisions shall be reviewed at the end of each reporting period 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 shall be reversed.

15. Application of Recognition and Measurement Rules The Standard discusses three important areas wherein the Recognition and Measurement Rules are applied. They are,

16. Application (contd) Future Operating Losses : Provisions shall not be recognised for future operating losses. Because, future operating losses do not meet the definition of a liability. Onerous Contracts : If an entity has a contract that is onerous, the present obligation under the contract shall be recognised and measured as a provision. Restructuring : 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 entity; or (b) the manner in which that business is conducted – for example, Sale or termination of a line of business; The closure of business locations in a country or region or the relocation of business activities from one country or region to another ; etc . A provision for restructuring costs is recognized only when the general recognition criteria for Provisions are met.

17. Disclosure For each class of Provision, an entity shall disclose the following details: The carrying amount at the beginning and end of the period; Additional P rovisions made in the period, including increases to existing provisions; Amounts used ( i.e., incurred and charged against the Provision) during the period; Unused amounts reversed during the period; and The increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate.

18. MCQ - 1 : Easy Go Ltd., is to prepare its annual accounts for the year ended 31 March 2017. A claim has damages for ` 1 crore for breach of patents and copyrights has been served on the company in January 2017. A competent firm of solicitors advises that the claim is highly frivolous without any basis and would not survive even in the first trial court. The company, however, anticipates a long drawn battle and huge legal costs. As a proper course of action about this issue, the company’s financial statements for the year ended 31 March 2017, Need not have any adjustment Make no disclosure as per legal advice Disclose both the compensation and the estimated legal expenses Make the disclosure only for estimated legal expenses Ans : (d)

19. MCQ - 2 : Contingency Assets, as per Ind AS – 37, are, Recognized in Balance Sheet if happening is almost certain Not recognized in Balance Sheet Disclosed in Notes to Accounts None of (a), (b) and (c) Ans : (b)

20. MCQ - 3 : When can a ‘Provision’ be recognized in accordance with IAS/Ind AS – 37? When there is a legal obligation arising from a past (obligating) event, the probability of the outflow of resources is more than remote (but less than probable), and a reliable estimate can be made of the amount of the obligation. When there is a constructive obligation as a result of a past (obligating) event, the outflow of resources is probable, and a reliable estimate can be made of the amount of the obligation. When there is a possible obligation arising from a past event, the outflow of resources is probable, and an appropriate amount can be set aside toward the obligation. When management decides that it is essential that a Provision be made for unforeseen circumstances and keeping in mind this year the profits were enough but next year there may be losses. Ans : (b)

21. MCQ - 4 : A competitor has sued an entity for unauthorized use of its patented technology. The amount that the entity may be required to pay to competitor if the competitor succeeds in the lawsuit is determinable with reliability, and according to the legal counsel, it is less than probable (but more than remote) that an outflow of the resources would be needed to meet the obligation. The entity that was sued should at year-end: Recognize a Provision for this possible obligation Make a disclosure of the possible obligation in the footnotes to the financial statements Make no Provision or disclosure and wait until the lawsuit is finally decided and then expense the amount on settlement, if any Set aside, as an appropriation, a contingency reserve, an amount based on the best estimate of the possible liability. Ans : (b)

22. MCQ - 5 : A factory owned by XYZ Inc., was destroyed by fire. XYZ Inc., lodged an insurance claim for the value of the factory building, plant, and amount equal to one year’s net profit. During the year, there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that XYZ Inc ., would receive compensation for 90% of its claim. XYZ Inc ., received a letter that the settlement cheque for that amount had been mailed, but it was not received before year-end. How should XYZ Inc ., treat this in its financial instruments? Disclose the contingent asset in the Foot Notes Wait until next year when the settlement cheque is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement cheque was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the Contingent Asset will be received Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement cheque was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the Contingent Asset will be received, and adjust the 10% next year when the settlement cheque is actually received Ans : (c)

23. MCQ - 6 : The Board of Directors of ABC Inc., decided on 15 March 2017 to wind up international operations in the Far East and move them to Australia. The decision was based on a detailed formal plan of restructuring as required by IAS/Ind AS – 37. This decision was conveyed to all workers and management personnel at the headquarters in Bengaluru. The cost of restructuring the operations in the Far East as per this detailed plan was ` 20 crore. How should ABC Inc., treat this restructuring in its financial statements for the year ended 31 March 2017? Because ABC Inc., has not announced the restructuring to those affected by the decision and thus has not raised an expectation that ABC Inc., will actually carry out the restructuring (and as no constructive obligation has arisen), only disclose the restructuring decision and the cost of restructuring of ` 20 crore in footnotes to the financial statements. Recognize a Provision for restructuring since the board of directors has approved it and it has been announced in the headquarters of ABC Inc., in Bengaluru. Mention the decision to restructure and the cost involved in the chairman’s statement in the annual report since it is a decision of the board of directors. Because the restructuring has not commenced before year-end, based on prudence, wait until next year and do nothing in this year’s financial statements. Ans : (a)

24. Illustration – 3 : Vishnu Company has at its financial year ended 31 st March, 2016, fifteen law suits outstanding and none of which has been settled by the time the accounts are approved by the directors. The directors have estimated that the possible outcomes as below. Outcome of each case is to be taken as a separate entity. Ascertain the amount of contingent loss and the accounting treatment in respect thereof. Probability (%) Loss ( ` ) For first ten cases - Win 0.6 Lose - low damages 0.3 90,000 Lose - high damages 0.1 1,60,000 For remaining five cases: Win 0.5 Lose - low damages 0.3 60,000 Lose - high damages 0.2 95,000

25. Illustration – 2 : At the end of the financial year ending on 31 st March, 2017, Counsle & Client Ltd., finds that there are 20 law suits outstanding which have not been settled till the date of approval of accounts by the Board of Directors. The possible outcome as estimated by the Board is as follows. Outcome of each case is to be taken as a separate entity. Ascertain the amount of contingent loss and the accounting treatment in respect thereof. Probability (%) Loss ( ` ) In respect of five cases (win) 100 - Next ten cases: W in 60 - Lose (low damages) 30 1,20,000 Lose (high damages) 10 2,00,000 Remaining five cases: Win 50 Lose (low damages) 30 1,00,000 Lose (high damages) 20 2,10,000

26. Illustration – 1: Sun Ltd., entered into a sale contract of ` 5 crore with X Ltd., during 2016-17 financial year. The profit on this transaction is ` 1 crore. The delivery of goods to take place during the first month of 2017-18 financial year. In case of failure of Sun Ltd., to deliver within the schedule, a compensation of ` 1.5 crore is to be paid to X Ltd. Sun Ltd., planned to manufacture the goods during the last month of 2016-17 financial year. As on Balance Sheet date (31 March 2017), the goods were not manufactured and it was unlikely that Sun Ltd., will be in a position to meet the contractual obligation. Should Sun Ltd., provide for contingency as per Ind AS – 37 (AS – 29)? Should provision is measured as the excess of compensation to be paid over the profit?