Indian Accounting Standard (Ind AS) 37 “Provisions, Contingent Liabilities and Contingent Assets”

Indian Accounting Standard (Ind AS) 37

“Provisions, Contingent Liabilities
and Contingent Assets”

1. Indian Accounting Standard (IndAS) 37
“Provisions, Contingent Liabilities
and Contingent Assets”
CMA Raman Khanna [email protected]

2. Objective
IndAS 37
is to ensure
appropriate
RECOGNITIONcriteria
and MEASUREMENT
basesare applied to
Provisions, Contingent
Liabilities
Contingent
Assets
sufficient information is
DISCLOSEDin notes
enabling users to
understand nature, timing
and amount.

3. Objective
PROVISIONS &
CONTINGENICES
RECOGNITION
Provision
Contingency
Contingent Asset
Contingent Liabilities
MEASUREMENT
Best estimate
Risks and uncertainties
Present value
Expected disposals of assets
Future Events
Expected disposal of assets
DISCLOSURE
Provision
Contingency

4. Scope: Standard applies to all entities for Provisions,Contingen t Liabilities & Contingent Assets except:
Exceptions
Executory Contracts Except
Onerous Contracts
Covered by another Standard

5. Scope:Exceptions-ExecutoryContractsExceptOnerousContracts
Executory
Contracts are
contracts under
which
Parties to contract have
NOT PERFORMED
any of its obligations or
Parties to contract have
PARTIALLY PERFORMED
their obligations to an equal extent

6. Scope:Exceptions-ExecutoryContractsExceptOnerousContracts-Examples Operating leases- Tenant is required to make periodic rental payments; landl ord required to provide accommodation. Equipment leases- lessee has to pay lease rent for equipment use; lessor has to provide equipment for use by the lessee. Real Estate Contracts– Developers develop the real estate; homebuyers to make the payment when milestones achieved Services Contracts- Future delivery of services such as gas and electricity aga inst payment Supply Contracts -On 01-Jan-2019 ABC Ltd. enter into a contract with XYZ Ltd. (m anufacturer) for delivery of 100 units of an Item at 4 different dates in future; Payment is due on delivery of unit s.
(Executory Contract)
•On 01-Jan-2018, contract between ABC Ltd. and XYZ Ltd. is exe cutory contract because neither party has performed any of i ts
obligations. XYZ Ltd. has not manufactured/delivered any o f the units, nor ABC Ltd. paid for any of them.
(Executory Contract)
•On 01-Mar-2018, XYZ Ltd. manufactured and delivered 200 uni ts and ABC Ltd. has made full payment for those 200 units. As on 01-
Mar-2018, the contract between ABC Ltd. and XYZ Ltd. continu es to be executory since both the parties have partially perf ormed their
obligations to an equal extent.
(Executory Contract)
•On 01-Apr-2018, XYZ Ltd. manufactured and delivered balanc e 200 units, but ABC Ltd. has made payment for 300 units only. C ontract
between ABC Ltd. and XYZ Ltd. is no longer meeting the definit ion of an executory contract because both the parties have no t
performed under contract to an equal extent. ABC Ltd. is requ ired to recognize a liability for 100 units for which it has to make
payment.
(Not Executory Contract)

7. Scope:OnerousContracts Ifanentityhasacontractthatisonerous,thepresentobligationunderthecontractshallbe
recognisedandmeasuredasaprovision
ONEROUS CONTRACT– A contract is an Onerous Contractin which
•UNAVOIDABLECOSTof meetingthe obligations under the contract
•EXCEEDtheECONOMICBENEFITSexpected to be received under it.
Onerous
Contract
Unavoidable
costs
Economic
benefits
>
……….Contd

8. Scope:OnerousContracts–UnavoidableCosts UNAVOIDABLE COSTS –Unavoidable costs under a contract reflect the LEAST NET COST OF EXITINGfrom the contract, which is the lower of:
Pthecost of fulfilling the contract or
Pany compensation or penaltiesarising from failure to fulfil the contract (Exit or breach of Contract)
Unavoidable
costs under a
contract is
lower of:-
Cost of fulfilling the contract
Any compensation or penalties arising from
failure to fulfil the contract

9. Example Contract Type and Recognition
(1) A Co. running a profitable business from a factory which i s on lease .
Monthly lease rents are Rs. 100,000 p.m. effective from 01-0 4-2018 for a
period of 5 years. On 31-03-2019 the market rent for the facto ry is Rs.
40,000 p.m.
Lease Contractis not onerous
(2) A Co. running a profitable business from a factory which i s on lease .
Monthly lease rents are Rs. 100,000 p.m. effective from 01-0 4-2018 for a
period of 5 years.
On 31-03-2019, Co. relocates its factory to a new location. T he lease on old
factory premises continues for the next 4 years, it cannot be cancelled and
cannot be sub-let to another tenant.
Lease Contractis onerous On 31-03-2019 the lease becomes onerous because
unavoidable costs (Rs. 48,00,000) exceed the economic
benefits expected to be received (Rs. NIL).
Therefore, a provision to be recognised for the present
value of unavoidable lease payments.
(3) A Co. running a profitable business from a factory which i s on lease.
Monthly lease rents are Rs. 100,000 p.m. effective from 01-0 4-2018 for a
period of 5 years.
On 31-03-2019, Co. relocates its factory to a new location. T he lease on old
factory continues for the next 4 years. The contract stipula tes a cancellation
fee of Rs. 20,00,000 and factory cannot be sub-let to another tenant.
Lease Contractis onerous On 31-03-2019, the lease becomes onerous because
unavoidable costs (lower of Rs. 48,00,000 and Rs.
20,00,000) exceed the economic benefits expected to be
received (Rs. NIL).
Therefore, a provision is recognised for the present value
of unavoidable lease payments.
Scope:OnerousContracts–UnavoidableCosts-Examples

10. Example Contract Type and Recognition
(4) A Co. running a profitable business from a factory which i s on lease.
Monthly lease rents are Rs. 100,000 p.m. effective from 01-0 4-2018 for a
period of 5 years.
On 31-03-2019, Co. relocates its factory to a new location. T he lease on old
factory continues for the next 4 years. The contract stipula tes a cancellation
fee of Rs. 20,00,000 and factory can be sub-let to another ten ant.
The expected market rental income from the factory is Rs. 75, 000 p.m.
Lease Contractis onerous 2 alternatives are available to exist the onerous contract.
Lessee should determine cheapest exit route out of two.
Alternate-1 On 31-03-2019, the lease becomes onerous
because unavoidable costs (lower of Rs. 48,00,000 and Rs.
20,00,000) exceed the economic benefits expected to be
received (Rs. NIL).
Alternative-2 Continue with lease at Rs. 1,00,000 p.m., plu s
sub-let the factory at an expected rental of Rs. 75,000 p.m.
It would result in a loss of Rs. 12,00,000 over the
remaining 4 years of lease contract.
The present value of net cost of continuing with the lease
is less than the penalty of exiting the lease. Therefore, on
31-03-2019, a provision shall be recognised for the present
value of Rs. 25,000 p.m. (Rs. 1,00,000 lease-rent minus Rs.
75,000 lease sub-let rental income) for remaining 3 years
of the operating lease.
Scope:OnerousContracts-Examples

11. Scope:Exceptions-CoveredbyanotherStandard
Financial
Instruments
(IndAS 109)
Income Taxes
(IndAS 12)
Leases
(IndAS 17)
Employees
Benefits
(IndAS 19)
Insurance
Contracts
(IndAS 104)
Contingent
liabilities in
business
combinations
Construction
Contracts
(IndAS 11)
Contingent
Consideration in
business
combinations
(Ind AS 103)
Revenue from
Contracts with
Customer
(IndAS 115)

12. TermDefinition
ProvisionIs aliabilityofuncertain timingoramount Liability
Is apresent obligationof the entity arising from past events, the settlement of whi ch is expected to
result in an outflow from the entity of resources embodyinge conomic benefits
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
Legal
Obligation
Is an obligation that derives from:
(a) a contract
(b) legislation; or
(c) other operation of law.
Constructive
Obligation
Is an obligation that derives from an entity’s actions where :
(a) by an established pattern of past practice, published po licies or a sufficiently specific current
statement, the entity has indicated to other parties that it will acceptcertain responsibilities; &
(b) as a result, the entity has created a valid expectation on the part of those other parties that it will
discharge those responsibilities.
Definitions:

13. TermDefinition
Contingent
Liability
(a) apossible obligationthat arises from past events and whose existence will be conf irmed only by
the occurrence or non-occurrence of one or more uncertain fu ture events not wholly within the
control of the entity; or
(b) apresent obligationthat arises from past events but is not recognized because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation; or
(ii) the amountof the obligation cannotbe measured with suf ficient reliability.
Contingent
Asset
Is apossible assetthat arises from past events and whose existence will be conf irmed only by the
occurrence or non-occurrence of one or more uncertain futur e events not wholly within the control of
the entity.
Definitions:

14. Differences
Existence of
“Present
Obligation”
Probability
of “Outflow”
Certainty of
“Amount”
Certainty of
“Time”
Liabilities (Trade Payables / Accruals)
Certain Certain Certain Certain
Provisions (Uncertainty of Amount)
Certain Certain
Uncertain
Certain
Provisions (Uncertainty of Time)
Certain Certain Certain
Uncertain
Contingent Liability ( PossibleObligation)
Uncertain
Certain Certain Certain
Contingent Liability ( PresentObligation)
Certain
Uncertain
Certain Certain
Contingent Liability ( PresentObligation)
Certain Certain
Uncertain
Certain
RelationshipbetweenProvisions,LiabilitiesandContingentLiabilities

15. RecognitionTest:Provisions An entity shall recognize a provision when below
three conditions
are met. It these conditions are not met, no provision
shall be recognised.
an entity has a present
obligation(legal or
constructive) as a result
of a past event
it is probablethat an
outflow of resources
embodying economic
benefits will be required to
settle the obligation
a reliable estimate
can be made of the
amount of obligation

16. RecognitionTest:Provisions-PresentObligation: PRECOGNISE- If it ismore likely than notthat a present obligation exists at the end of the reporting p eriod, (if
recognition criteria are met) -
PROVISION
PDISCLOSE-If it is more likely that no present obligation exists at the end of the reporting period-
CONTINGENTLIABILITY
PastEvent: PA past event that leads to a present obligation is called an ob ligating event
PObligating Event - Is an event that creates a legal or constructive obligation that results in an entity having no realistic
alternative to settling that obligation
PRECOGNISE- Only those liabilities that exist at the end of reporting period . PNO PROVISONRECOGNISED– For costs and events to be incurred in future.
Present obligation
It is as a result of PAST EVENTonly It can be either a LEGALor CONSTRUCTIVEobligation

17. RecognitionTest:Provisions-PresentObligation:
Virtually Certain:
Probability of more
than 95%
More likely than not:
Probability of more
than 50%
Possible not Probable:
Probability of 5% to
50%
Remote:
Probability of less than
5%
Probable-More likely than not

18. Recognition Test: Provisions - Probable outflow of resources embodying economicbenefits PDISCLOSE as CONTINGET LIABILITY– If it isnot probablethat apresent obligation exists , an entity discloses a
contingent liability and possibility of an outflow of resources embodyingeconomic benefits is remote.
Probable
Outflow
A Probability
of an outflow of resourcesembodying economic
benefits to settle that obligation

19. RecognitionTest:Provisions–ReliableEstimateoftheObligation

20. RecognitionTest:ContingentLiabilities PDISCLOSE- A contingent liability. PNOT DISCLOSE- If thepossibility of an outflow of resources embodyingeconomic benefits is remote PPARTIAL DISCLOSE PARTIAL RECOGNISE– If an entity is jointly and severally liable for an obligati on, the part of the
obligation that is expected to be met by other parties is trea ted as a contingent liability. The entity recognises a
provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable,
exceptin the extremely rare circumstances where no reliabl e estimate can be made.
PINITIAL CONTINGENT LATOR PROVISION- If it becomes probable that an outflow of future economic be nefits will be
required for an item previously dealt with as a contingent li ability, a provision is recognised in the financial stateme nts
of the period in which the change in probability occurs (exce pt in the extremely rare circumstances where no reliable
estimate can be made).
An entity shall not recognisea contingent liability

21. RecognitionTest:ContingentAssets PContingent assets usually arise from unplanned or other unexpected eventsthat give rise to possibility of an inflowof
economic benefits to the entity.
PNOT REGCOGNISE– Contingent assets are not recognised in financial stateme nts since this may result in recognition of
income that may never be realised.
PREGCOGNISE– If realisation of income is virtually certain, the asset and related income are not contingent and it is
recognized in financialstatements of the period in which ch ange occurs
PDISCLOSE- A contingent assetis disclosed, where an inflow of economi c benefits isprobable.
PCONTINUOUS ASSESSMENT- Contingent assets are assessed continually to ensure thatdevelopments are
appropriately reflected in financialstatements.
An entity shall not recognisea contingent asset

22. Measurement:Bestestimate Principlesfordeterminingbestestimates 1) Best estimate of the expenditure required to settle prese nt obligation is the amount that an entity would rationally
payto settle the obligation at the end of the reporting period or to transferit to a third party at that time.
2) The estimates of outcome and financial effect are determi ned:
•by thejudgementof the managementof the entity,
•supplemented byexperience of similar transactions and, •in some cases,reports from independent experts.
3) Provision for large population of items– Obligation is estimated by weighting all possible outcome s by their
associated probabilities.Such statistical method of esti mation is named as “expected value”
4) Provision for Single obligation – Obligation is estimated at the most likely outcome.
5) Provision is measuredbefore tax.
Amount recognised as a provision shall be the best e stimate of the expenditure
required to settle the present obligation at the en d of the reporting period

23. Measurement:Riskanduncertainties PThese need to be factored in making judgements under conditi ons of uncertainty, so that income or assets are not
overstated and expensesor liabilities are not understated
PDISCLOSE- Uncertainties surroundingthe amountof the expenditure.
Measurement:PresentValue PDiscount the provisions, where the effect is material . Due to time value of money, provisions relating to cash outf lows
that arise soon after the reporting period are more onerous t han those where cash outflows arise later.
PDiscount rate / rates shall be a pre-tax rate / rate that refle ct(s) current market assessments of the time value of
money and the risks specific to the liability.
The risks and uncertainties that inevitably surroun d many events and circumstances
shall be taken into account in reaching the best es timate of a provision
Where effect of the time value of money is material , the amount of a provision shall be
the present value of the expenditures expected to b e required to settle the obligation.

24. Measurement:FutureEvents Measurement:Expecteddisposalofassets PGains on expected disposal of assets are not taken into accou nt in measuring a provision, even if the expected disposal
is closely linked to the event giving rise to the provision.
Future events that may affect the amount required t o settle an obligation shall be reflected in
the amount of a provision where there is sufficient objective evidence that they will occur.
Gains from the expected disposal of assets shall no t be taken into account in
measuring a provision

25. Reimbursement: If any expenditure required to settle a provision is to be rei mbursed by another party, the reimbursement shall be
recognised when it isvirtually certainthat it will be received if the entity settles the obligation . Reimbursement shall be
treated as a separate asset. Amount recognised for reimburs ementshallnot exceed the amountof provision.
In Profit and Loss A/c - Expense relating to a provision may be presented net ofamount recognised for a reimbursement.
In Balance Sheet – The Asset and Provision are not net ofand presented separately under different heads. Example:
• Supplier shall reimburse
warranty claim to ABC Ltd.
Supplier
• ABC Ltd. Shall accept the
customer claim and recognize
provision and reimbursement
ABC Ltd.
• Customer raise the claim
for defective item and get it
from ABC Ltd.
Customer

26. Changesinprovisions: PREVIEW- Review Provisionsat the end of each reportingperiod and ad just it to reflect the current best estimate. PREVERSE- If it isno longer probablethat an outflow of resources embodying economic benefits wi ll be required to
settle the obligation, the provision shall be reversed.
PINCREASE IN PROVISIONS AS BORROWING COST–Where discounting is used, the carrying amount of a provisi on
increases in each period to reflect the passage of time. This increase is recognised as borrowing cost.

27. Applicationoftherecognitionandmeasurementrules: Futureoperatinglosses …NOT RECOGNISED- Provisionsshall not be recognised for future operatinglo sses as there isno past event. …Future operating lossesdo not meet the definition of a liability and general recogni tion criteriaset out for provisions
in the Standard.
…An expectation of future operating losses is an indication t hat certain assets of the operation may be impaired. An
entity tests these assets for impairmentunder Ind AS 36, Impairment of Assets.
Futureoperatinglosses
…Refer initial slides.
Future operating losses
Onerous contracts
Restructuring

28. Applicationoftherecognitionandmeasurementrules:
Restructuring
PExamplesof restructuring:
(a) sale or termination of a line of business – (Demerger or sl ump sale)
(b) closure of businesslocations in a country / region / relo cation of business from one country / region to another
(c) changes in managementstructure, for example,eliminat ing a layer of management
(d) fundamentalreorganisationsthat have a material effec t on the nature and focus of the entity’s operations.
PProvision for restructuringcosts is recognised only when g eneral recognition criteria for provisionsare met.
PA constructive obligation to restructure arises only when a n entity:
(a) has a detailedformal planfor the restructuringidentifying at least:
(i)business or part of a business concerned; (ii)principal locationsaffected; (iii)location, function, & approximate no. of employees who will be compensated for terminating their services (iv)expendituresthat will be undertaken; (v) when the plan will be implemented;
(b) hasraised a valid expectation in those affected that it will carry out restructuring by sta rting to implement that plan or announcingits main features to those affected by it.

29. Applicationoftherecognitionandmeasurementrules:
Restructuring
PNo obligation arises for the sale of an operation until there is a binding sale agreement.
PA restructuringprovision shall include only direct expend ituresarising from restructuring, and shallbe
a) necessarily entailed by the restructuring; and
b) not associated with the ongoingactivities of the entity.

30. Disclosure:
DISCLOSURE
PROVISION
Reconciliation
Brief Description
Indication of uncertainties Expected reimbursement
CONTINGENT
LIABIILITY
Brief Description
Estimate of Financial Effect Indication of uncertainties
Possibility of reimbursement
CONTINGENT
ASSET
Inflow is probable

31. Disclosure:Provision For each class of provision, an entity shall make reconcilia tion and disclose as under:
(a)Opening Balance
(b)additional provisionsmade in the period, including increases to existing provisi ons; (c)amounts used/Chargedagainst the provision during the period (d)unused amounts reversedduring the period; (e) Impactdue toIncreasein discounted amountarising from passage of time (f) Effect ofany change in discount rate . (g)Closing Balance
For each class of provision, a brief description of:
a) nature;
b) timing of expected outflow;
c) indication of uncertainties about amount and timi ng;
d) assumptions relating to future events;
e) expected reimbursement, if any.

32. Disclosure:ContingentLiability For each class of contingent liability:
a) description of the natureof contingent liability;
b) anestimate of financialeffect ; c) indication of uncertainties relating to the amountor timing of any outflow; d) possibility of any reimbursement
Disclosure:ContingentAsset With respect to contingent asset:
a) description of the natureof contingent asset; and
b) if possible, anestimate of financialeffect .
rWhere any of the information required to be disclosed in the c ontext of contingent liabilities and contingent assets is
not disclosed because it is not practicable to do so, that fac t shall be stated.
rIn extremely rare cases, disclosure of any information in th e context of provision / contingent liability / contingent a sset
may seriously affect the position of entity in a dispute with other parties on the subject matter of the provision /
contingent liability / contingent asset. In such cases, an e ntity need not disclose the information, but shall disclose
general nature of dispute, together with the fact that, and r eason why the information has not been disclosed

33. This ppt is prepared with an effort to simplify the contents a nd strengthen the understanding and is meant
to share the knowledge with professional colleagues, stude nts, academicians and interested public.
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