International Accounting

8th. week

Recognition of provisions in accordance with IFRS

According to Act on Accounting (SR) 431/2002 Col.

of Laws, § 26, article 5:

Provisions are liabilities of uncertain timing or amount

The same definition is stated by IAS 37.10

Liability is either present legal or constructive 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.

Legal vs. constructive obligation

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 (e. g. application of judicial precedents)

A constructive obligation is an obligation that derives from an entity’s actions:

(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.

Legal vs. constructive obligation

Argent Co. is a mining company located near Scarborough village in Lantania (country).

Even though there was a draft for a new legislation, which will ban any toxic agents used in production or domestic purposes, the act has not been approved yet; in addition, there is no legal responsibility of mining companies for any damage made on environment

In 2009, there Argent Co. has issued press release about two major cases of leakage of such toxic agents

Scarborough brings a case against Argent Co, however, the court dismissed a charge

Quite recently (autumn 2010) CEO of the Argent company has promised that company will pay for any damage resulting from past, present or future leakage of such agents

Legal vs. constructive obligation

Until autumn 2010, there was neither legal, nor constructive obligation of Argent Co. (and hence, no environmental liability)

However, because of the public promise, constructive obligation has arisen

Argent Co. need to estimate its expenditures required for restoration of environment due to past, present and future damages

Because „new liability“ will arise, Argent Co. shall account for expense as well

Framework (70b): Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

However, there is a catch! In 2010, the estimated profit (before public promise has

been made by the CEO) has been measured at 4 000 000 €

In 2011, it is assumed, that loss will account to 2 000 000 €

Provision for future environmental damages has been

estimated in 2010 at 2 900 000 €

In 2010, only 400 000 € has been required for settlement of

any claims related to environmental damages

However, there is a catch!

4 000 000

-2 000 000 -2 900 000

3 300 000

1 100 000 1 300 000

-4 000 000

-3 000 000

-2 000 000

-1 000 000

0

1 000 000

2 000 000

3 000 000

4 000 000

5 000 000

2010 2011

Profit before provisions

Impact of creation of provision on profit/loss

Impact of reversal of provisions on profit/loss

Profit after provisions

Recognition of provisions in accordance with IFRS

There several IFRS´s, which are focused on provisions

In general, there is IAS 37

However, provisions are also dealt with in:

IAS 16.16c (estimated expenditures for dismantling and disposal of an asset and restoration of surroundings is part of a cost of the non-current tangible asset)

IAS 39.47c (accounting for financial guarantee)

IAS 18.19 (recognition of revenues from sale of goods if only the reliable estimation of warranty cost could be made)

IAS 11.22, 36 (if there is an expectation, that the construction contract will result in loss, the company should apply provision-like approach – i. e. immediate recognition of loss)

Provision for dismantling In accordance with IAS 16.16c estimated expenditures

for dismantling and disposal of an item and restoration of

surrounding are included in the (acquisition) cost of a

non-current asset, if such obligation arise upon

acquisition or during the use of such asset

If such obligation arise from law or contract, it is a legal

obligation)

If it results from customs, habits or it is a result of an effort

focused on improving relations with local community, it is

a constructive obligation

Provision for dismantling For example, the purchase cost of a machinery has

been 240 000 €, its transportation cost has been 5 000 €,

expenditures related to training of employees are 15 000

€ and the total expenditures for dismantling and disposal

are estimated at 2 400 €

Provided that there is a 2 % discount rate and the

estimated useful life the machinery are 6 years, what will

be carrying amount of machinery recognized upon initial

recognition?

Provision for dismantling 240 000 €

+ 5 000 €

+ 2 174 € (=

247 174 € Year EB Interest rate Interest BB

5 2 400 2% 47 2 353

4 2 353 2% 46 2 307

3 2 307 2% 45 2 262

2 2 262 2% 44 2 217

1 2 217 2% 43 2 174

Valuation / Measurement According to the Act on Accounting in SR:

§ 25: assumed liabilities are measured at cost, liabilities originating in company are measured at nominal value; liabilities acquired through the purchase of another business are measured at fair value

However, § 25, article 6 states:

For the purpose of this Act ... cost is the price, for which the asset has been acquired, and other expenditures, directly related to such acquisition ....

.... nominal value .... is the amount at which .... the liability is stated ...

Provisions are liabilities of uncertain .... amount

What is the amount at which the liability of uncertain amount is stated ?

Valuation / Measurement IAS 37.36 states, that provisions should be measured at best estimate of the expenditures which will be at the (current) reporting date required for settlement the obligation

E. g., the employee is currently entitled for benefit worth 1 210 €, but the amount would be paid to him only after two years upon his written request; bank interest rate is 10 % p. a. (net of tax)

How much the company need at the current reporting date, in order to either settle the obligation with employee, or transfer it to another party?

1 000 € only.

IF the amount would be deposited in bank, the interest for 1st year would be 100 € and for the 2nd year 110 € (10 € in excess of the 1st

year is the result of compound interest.

Consequently, the total amount after two years would be 1 210 €

Valuation / Measurement However, there might be several estimates (with different

amounts) available

Od, the estimate is stated as a range, rather than as

a single number?

For example, there is 20 % probability, that the warranty

costs (for repair of your goods) will be 100 000, 50 %

probability that it will be 200 000 and 30 % probability

of 300 000

Or, estimated expenditures are within the range

(100 000; 300 000 €)

Valuation / Measurement For example, there is 20 % probability, that the warranty costs (for repair of your goods) will be 100 000, 50 % probability that it will be 200 000 and 30 % probability of 300 000

In accordance with IAS 37.39 the provision should be measured as follows:

20 % x 100 000 + 50 % x 200 000 + 30 % x 300 000; 210 000

Estimated expenditures are within the range (100 000; 300 000 €)

In accordance with IAS 37.39, if all alternatives within the range has the same probability, midpoint of the range (200 000) is selected as a amount of related provison

Valuation / Measurement If the impact of time value of money is assessed to be

material, provisions should be estimated from the

discounted expenditures

Materiality is defined in IAS 8 (in a narrative, rather than

quantitative form)

For discounting, discount rate reflecting time value of

money and specific risk of the liability should be applied

Specific risk should be included either in the amount of

estimated expenditures or in discount rate; double

counting the risk is prohibited

Reimbursements, creation, use

and reversal of provisions Reimbusements are accounting for in accordance with

IAS 37.53

Creation and reversal of provisions is made through profit

or loss*, they are used in accordance with the purpose

for which they have been created

No provision shall be created for general risk, repairment

of non-current assets or for the impairment of assets

Creation of provisions Creation of provisions is accounted for through profit or

loss, with certain exceptions:

a) provisions for restructuring

b) provisions to be account for as a result of production

Provisions related to production Best estimate of expected expenditures have to be

capitalized

In continental Europe, you would recognized both

expenses and income at the same amount

Only impact on profit or loss will arise in the period when

production will be consumed, impaired or sold

Provisions for restructuring They are covered in IAS 37 in great detail

The reason is, that they are related to business

combinations

In accordance with IFRS 3, positive excess of

consideration provided for the interest in certain

company over its net assets as recognized as goodwill

Provisions for restructuring For example, for 800 you have purchased 100 % interest (share) in Sharkie Co., which has assets worth 1 000 and liabilities equal to 400

Net assets are 600, you have paid 800, the result is goodwill (asset) recognized at 200

However, if you (as a new owner) want to terminate contracts with employees of your subsidiary in exchange for flat benefit, provision for restructuring should be recognized

However, increase of provision results in decrease of net assets by 100 and hence increase of goodwill by the same amount

According to IAS 36, goodwill is tested for impairment rather than depreciated,

However, if (after 2 yours) you change your plan, the provision should be reversed ...

... WHICH IS DONE THROUGH PROFIT OR LOSS

Provisions for restructuring In accordance with IAS 37.72, provision for restructuring should be recognized if entity:

(a) has a detailed formal plan for the restructuring identifying at least:

(i) the business or part of a business concerned;

(ii) the principal locations affected;

(iii) the location, function, and approximate number of employees who will be compensated for terminating their services;

(iv) the expenditures that will be undertaken; and

(v) when the plan will be implemented; and

(b) has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.

Disclosure of related information

IAS 37.84 and further

Reconciliation of beginning and ending balances

Information on use of judgments and estimates (e.g.

discount rates, reimbursements)

In accordance with IAS 37.92, certain sensitive

information need not be disclosed ....

On the other hand if not remote, contingent assets and

liabilities have to be disclosed

Contingent assets and contingent liabilities

A contingent liability is:

(a) a possible obligation ... whose existence will be

confirmed only by .... uncertain future events not

wholly within the control of the entity (there is a legal

dispute)

(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 (e. g. the likelihood is lower than

it is required under IAS 37.15)

(ii) the amount of the obligation cannot be

measured with sufficient reliability

Contingent assets and contingent liabilities

A contingent asset is a possible asset ... whose

existence will be confirmed only by ... uncertain future

events not wholly within the control of the entity

Zamestnanecké požitky

V princípe upravované:

IAS 19 (všeobecný štandard)

IFRS 2 (ak sú požitky viazané na akcie)

IAS 26 (výsledky fondu zamestnaneckých požitkov)

Zamestnanecké požitky podľa IAS 19

Zamestnanecké požitky (ang. employee benefits):

a) krátkodobé

b) dlhodobé

Požitky, nie pôžitky!

Dlhodobé zamestnanecké požitky:

a) pri predčasnom ukončení zamestnania

b) po ukončení zamestnania

c) ostatné dlhodobé zamestnanecké požitky

Rozlišovanie prev{dzkových

a finančných n{kladov Používa sa metóda očakávaných jednotiek zásluhovosti (ang.

Projected Unit Credit Method) Počet rokov za ktoré sa počítajú n{roky 5

N{roky za každý odpracovaný rok 400

N{roky spolu 2 000

Diskontn{ sadzba 3,0%

1 2 3 4 5 SPOLU

Zamestnanecké požitky v poslednom roku

400 400 400 400 400 2 000

Odúročenie 1,126 1,093 1,061 1,030 1,000 x

Zamestnanecké požitky bežného obdobia

355 366 377 388 400 1 487

1 2 3 4 5 SPOLU

Zamestnanecké požitky na zač. obdobia (Z)

0 355 732 1 131 1 553 x

Úroky 0,000 10,662 21,963 33,933 46,602 67

Zamestnanecké požitky bežného obdobia (N)

355 366 377 388 400 1 487

Zamestnanecké požitky na konci obdobia (Z)

355 732 1 131 1 553 2 000 x