Executive Education Series: IFRS - IAS 37 Liabilities, Provisions

and Contingencies

Presented by: Marco Pulido, Shareholder

November 12, 2013

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Before We Get Started…

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CPE Credit

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Marco Pulido, CPA Shareholder 310.268.2746 | mpulido@cbiz.com Marco has over 14 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards both in the U.S. and in Latin America with Big Four accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution and Manufacturing - Transportation - Utilities - Consumer Services - Construction/Real Estate - Health Sciences – Financial Services – Agriculture.

Today’s Presenters

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The information in this Executive Education Series

course is a brief summary and may not include all the details relevant to your situation.

Please contact your MHM service provider to further

discuss the impact on your financial statements.

Disclaimer

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Identifying differences between IFRS and U.S. GAAP

Today’s Agenda

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IAS 37 key definitions

Identify transactions within the scope of IAS 37

Describe the requirements for recognizing provisions Describe the requirements for disclosing contingent assets and liabilities Measuring provisions

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Provision: A liability of uncertain timing or amount.

Liability: A present obligation as a result of past events the settlement of which is expected to result in an outflow of resources.

Contingent liability: A possible obligation depending on the occurrence/ nonoccurrence of uncertain future events, or a present obligation but no probable outflow of economic benefits or amount cannot be reliably measured.

Contingent assets: A possible asset that arises from past events and whose existence will be confirmed only by the occurrence/nonoccurrence of uncertain future events. Contingent assets are not recognized, but are disclosed if probable. When realization is virtually certain, the asset is no longer a contingent asset.

IAS 37 Key definitions

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Relates to provisions and contingent assets/liabilities

Out of scope: Financial instruments valued at fair value (FV) Executory contracts, unless they are onerous contracts Insurance contracts Provisions covered by other IFRS: Construction Contracts (IAS 11) Income Taxes (IAS 12) Employee Benefits ( IAS 19) Leases (IAS 17) Business Combinations (IFRS 3) Insurance Contracts (IFRS 4)

<IAS 37. IN1, 1 and 5>

Scope

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Recognition – Provisions

Will be recognized when:

• There is a present obligation (legal or implicit), derived from a past event.

• An outflow of resources to settle the liability is probable (>50%)

• An estimate may be reliably measured

A PROVISION is a liability,

which settlement amount is not known when

incurred

• In contrast, accounts payable are liabilities for goods or services that have already been received in which the level of uncertainty is minimal.

• Not provisions: Adjustments to the book value of assets — such as depreciation, allowance for doubtful accounts, impairment of assets.

<IAS 37. 7, 10, 11, 14>

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Example – When should a provision be recognized in accordance with the definition of probable

Recognition – Provisions

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Situation Provision? Contingent liability disclosure?

There is a possible obligation or a present obligation where the likelihood of an outflow of resources is remote.

No No (IAS 37: 86)

There is a possible obligation or a present obligation that may, but probably will not, require an outflow of resources.

No Yes, disclosures are required for the

contingent liability. (IAS 37: 86)

A past event occurred which has resulted in a present obligation that probably requires an outflow of resources.

Yes Yes, disclosures are required for the

provision. (IAS 37: 84-85)

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Recognition – Contingent Liability

Is an obligation: That possibly 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 recognized because:

it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

the amount of the obligation cannot be measured with sufficient reliability.

<IAS 37. 10>

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Provision, contingent liability or nothing?

Provision

Yes

Remote? Probable outflow?

Reliable estimate?

Disclose contingent liability Do nothing

No

No

No

No

Yes

Yes

Yes

Yes

No

Present obligation as a result of an

obligating event? Possible obligation

Recognition

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A possible asset that arises from past events and whose existence will be confirmed only by the occurrence/ nonoccurrence of uncertain future events that are not under the control of the company

When the realization of income is virtually certain, then the

related asset is not a contingent asset and its recognition is appropriate.

<IAS 37. 10, 31, 33, 34, and 35>

Recognition – Contingent Assets

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Contingent assets are not recognized as an asset, instead, they are disclosed, when an inflow of economic benefits is probable.

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Example: Recognition of contingent liabilities and assets Background: An entity is a defendant to a lawsuit that has a high probability of loss. If the entity incurs a loss, the entity’s insurance company may cover the loss. Question: What amount should the entity recognize as an asset and liability, if any?

Valuation

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Example: Recognition of contingent liabilities and assets Background: An entity is a defendant to a lawsuit that has a high probability of loss. If the entity incurs a loss, the entity’s insurance company may cover the loss. Question: What amount should the entity recognize as an asset and liability, if any?

Valuation

Answer: • The entity should recognize a provision for the full liability, as it is highly probable

to occur. • Must confirm that the loss on the lawsuit and recoverability of the claim from the

insurance company are due to the same past event. • The entity should assess the effectiveness of the insurance policy. Unless there is

doubt over the success of the insurance claim, the entity should recognize a reliable estimate of the recovery.

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Valuation – Best Estimate

Estimate of outcome

Time value of money

• Judgment of management

• Experience with

similar transactions

• Independent expert opinions

• Evidence provided by

events after the reporting period.

The amount that an entity would rationally pay to settle the obligation at

the end of the reporting period or to transfer it to a third party at that time

<IAS 37. 36 and 38>

The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

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Valuation – Best Estimate

<IAS 37.39 - 51>

Two methods for calculating best estimate:

A large population of items

EXPECTED VALUE Estimated by weighing all

possible outcomes

MOST LIKELY OUTCOME However, must consider all

possible outcomes Individual case

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Example: How to determine the probability that an obligation will occur Background An entity is faced with one individual case. The judgment has a probability of a:

40% win, with no loss, and 60% loss, with a loss of $1 million

Question Should a provision be recognized, and if so, for what amount?

Valuation

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Example: How to determine the probability that an obligation will occur Background An entity is faced with one individual case. The judgment has a probability of a:

40% win, with no loss, and 60% loss, with a loss of $1 million

Question Should a provision be recognized, and if so, for what amount?

Answer Yes, for $1 million, since it is probable that a loss will be incurred.

Since this is a single case, a provision is recorded based on the most probable outcome.

The expected value method would not result in a reasonable estimation since a provision of $600,000 is not a result that may occur (only probable result is $1 million or $0).

Valuation

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Example 2: How to determine the probability that an obligation will occur Background

An entity is faced with 100 legal cases Each judgment has a probability of a:

40% win, with no loss, and 60% loss, with a loss of $1 million per judgment

Question Should a provision be recognized, and if so, for what amount?

Valuation

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Example 2: How to determine the probability that an obligation will occur Background

An entity is faced with 100 legal cases Each judgment has a probability of a:

40% win, with no loss, and 60% loss, with a loss of $1 million per judgment

Question Should a provision be recognized, and if so, for what amount?

Answer

Yes, a provision for $60 million [(100 × $1 million) × 60%] A provision is recognized using the expected value method since there is a

large population of items.

Valuation

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Example 3: How to determine the probability that an obligation will occur Background

An entity provides product warranties for products sold for a cost of $1 million Based on experience, there are different probabilities:

29.5% of only 1 failure 50.5% of 2 failures 20% of 3 failures

Question Should a provision be recognized, and if so, for what amount?

Valuation TRANSLATE TO ENGLISH

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Example 3: How to determine the probability that an obligation will occur Background

An entity provides product warranties for products sold for a cost of $1 million. Based on experience, there are different probabilities:

29.5% of only 1 failure 50.5% of 2 failures 20% of 3 failures

Question Should a provision be recognized, and if so, for what amount?

Answer Yes, for $2 million

The expected value is $1.91 million [(29.5% × $1M) + (50.5% × $2M ) + (20% × $3M)]

The probable value of the loss is $2 million (failed twice) The expected value method supports the recognition of a provision for the most

probable value IAS 37.40 implicitly indicates that when the most probable value and the expected value do not reflect similar results, normally it will be appropriate to recognize the result that reflects the expected outcome.

Valuation TRANSLATE TO ENGLISH

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Valuation – Financial Effect i.e. Discounting the Provision/Liability

Discount Rate

• Before income tax rate

• Consider the risks specific to the liability

• Reflects the market assessments performed on the time value of money

The provision will increase in each period to reflect the passage of time, with a charge to interest expense. (Effective interest method)

<IAS 37. IN6, 47 >

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Valuation – Reimbursements Reimbursements expected for existing provisions An asset will be recognized when a reimbursement is virtually guaranteed.

For the entire or a portion of the liabilities that will be settled.

It will be treated as a separate asset and will not exceed the amount of the provision.

<IAS 37.53 and 54>

Income Statement: The provision expense is presented net of the asset

recognized for the reimbursement.

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Provisions should be reviewed at each balance sheet date and adjusted to reflect the best estimate at such date.

If the outflow of resources becomes unlikely, the provision should be reversed.

Provisions should be used only to meet expenditures for which they were created.

<IAS 37. 59 and 61>

Changes in Provisions

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These are examples of events that may fall under the definition of restructuring:

sale or termination of a line of business the closure of business locations changes in management structure — for example, eliminating a

layer of management fundamental reorganizations that have a material effect on the

nature and focus of the entity's operations

Key condition for recognizing a provision: A binding sale agreement must be present.

Provisions for Restructurings

<IAS 37.10, 70, 78>

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IFRS vs. U.S. GAAP – Key Differences

IFRS U.S. GAAP

1. Probable defined as “more-likely-than-not” (50%)

2. Measurement of provisions When there is a range of equally likely outcomes, the low end of the range is accrued.

3. Discounting provisions Frequent updates will be necessary since discount rate will be updated at each period

4. Restructuring provision Entity must be committed to a sale, i.e., binding sale agreement

1. Probable is defined as “likely to occur” (generally considered 70% to 80% likelihood)

2. Measurement of provisions When there is a range of equally likely outcomes, the middlepoint of the range is accrued.

3. Discounting provisions Discount rate used should be the same rate when the provision is first recorded

4. Restructuring provision Provision recorded when entity is “demonstratably committed” to a plan

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Questions?

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View recordings of these previous EES courses: IFRS: Impairment of Assets Comparing the AICPA's Private Company Framework to

IFRS for SMEs

Read this related publication: Messenger 14-12: The SEC’s Report on IFRS - Steps Companies

Can Take Now

If You Enjoyed This Webinar…

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Marco Pulido, CPA Shareholder 310.268.2746 | mpulido@cbiz.com Marco has over 14 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards both in the U.S. and in Latin America with Big 4 accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution & Manufacturing - Transportation - Utilities - Consumer Services - Construction/Real Estate - Health Sciences – Financial Services – Agriculture.

Today’s Presenters

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