Overview of the Relevant International Accounting Standard - Essay Example

Contents Overview of the relevant international accounting standard (IASB) 2 Recognition, Measurement, presentation and disclosure details  3 Comparison with the US GAAP  7 Example from annual report [5] 8 Discussion 9 Overview of the relevant international accounting standard (IASB) Provision can be defined as a liability of uncertain timing or amount. Whereas contingent liability, as per IAS 37, is the present obligation in respect of past event the settlement requiring outflows of resources. Similarly, contingent asset also arises due to past events which are expected as an inflow of economic resources to the entity. Both contingent assets and contingent liabilities are not recognized but disclosed in the financial statement of the company. The main focus and objective of the standard is that the entity recognizes provision in its balance sheet with is the best estimate of the expenditure to settle an obligation at the end of its financial year. This estimate is the amount of cash outflow that the entity is likely to pay in the future. IAS 37 requires the corporation to take into consideration the following essentials when recording provisions in its financial statements, Take all the future and probable risks and uncertainties into account Calculate the present value of the provision by selecting a suitable discount rate. This will represents the current market value of the assessment of the future outflow of economic benefits Take future changes, such as law and changes in technological changes into consideration Expected disposals form the assets are not taken into consideration no matter how closely the disposal of asset is linked to determining the provision Similarly, there are circumstances in which provision is closely linked to the recognition of revenue; an example would be when an entity gives guarantees in exchange for a fee. The recognition, measurement and accounting specification are mentioned in IAS 18 ‘Revenue’ Discussing the scope of IAS 37 < http://www.iasplus.com/en/standards/standard36>[1], the standard is applied by all entities on accounting for provisioning except those resulting from executor contracts and those covered under other standards such as provisions pertaining to construction contracts (IAS 11), income taxes (IAS 12), employee benefit (IAS 19) and insurance contracts (IFRS 4). IAS 37 is also not applicable to financial instruments. Recognition, Measurement, presentation and disclosure details  The International Accounting Standard (IAS) 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ describes the accounting treatment in respect of financial provisions, contingent assets and contingent liabilities. In this context IAS 37 (2009, p 1888) describes that the entity only recognizes a provision, if the following conditions prevails which are: A present obligation has arise due to certain past event The outflow of economic resources, in order to settle that obligation, is probable; and The settlement amount can be reliably measured [2] Further elaborating on the above mentioned points, an obligating event is the one according to which the company has a legal or constructive obligation to settle that obligation and the company does not have any other alternative to that. As further explained in the relevant provisions of IAS 37, a constructive obligation usually arises on account of past practices. In certain circumstances, it might not be certain whether the entity has a present obligation, and even if it does have a present obligation, the outflow of economic resources out of the entity is not certain. The discussed circumstances give rise to a contingent liability, which is required to be disclosed in the financial statement of the company and does not need to recognize. If the possibility of economic out flow is highly remote, then the company is not required to even disclose it in its financial statements. The amount recognized as provision should be the best estimate of the expenditure that is required to settle the present obligation at the balance sheet date. The entity, while recording the provisions, should take into account all the relevant circumstances and risk that prevails at the balance sheet date. In some situations, it would be possible that a third party agrees to agree the whole or certain part of the asset. In such situations the entity should recognize the amount receivable in the form of reimbursement as asset. The following example further clarifies Company Alpha has decided to set up a temporary working facility in the southern area of the city. At the reporting date, the company recognizes a provision on account of dismantling of the working facility which will going to take place after 2 years of the reporting date. The amount of provision is recorded at 40,000$. The local government, being impressed from the social and corporate profile of the company, has decided to reimburse to the company, 80% of the cost of dismantling. At reporting date Cost of the asset 40,000 (Debit) Provision on account of Dismantling 40,000 (Credit) Receivable from Government 32,000 (Debit) P&L Income 32,000 (Credit) The amount of provision recorded should be reviewed at each balance sheet date, and if the outflow of economic resources is not probable, then the entity should reverse the provision. IAS 37 specifically talks about the restructuring provisions, according to which the amount of provision should only include direct expenditures caused by the restricting and not pertaining to the ongoing activities. Following representation further clarifies. Event Accounting treatment Sale of operation Provision is accrued only after a binding sale agreement Closure or reorganization Accrue only after a detailed formal plan is finalized Future Operating losses No provision should be recorded Restructuring provision on acquisition Provision is only recorded in case of obligation at acquisition date The following decision tree as presented in IAS 37 (2009, Appendix B, p 1903) presents the guidelines based on which the amount are disclosed or recognized in the financial statements of the company [3] The measurement section of IAS 37 also bring into attention of the companies that the recorded provisions should be the best estimate. The process of determining the best estimate of the provision is purely dependent on the judgment of the management which in turn is ultimately dependent upon the report of the experts or the experience gained from similar transitions. The company usually calculates a midpoint value based on the weight ages of different probabilities. For example the possibility of recorded a provision is 60%, 70% and 90% and each percentage is associated to a different set of risk, then the management of the entity will recorded the provision based on the weight age of different risks level. In addition, the standards also requires that the future events that are likely to affect the provision in the future period should be assessed at the reporting date at the affects of that must be reflected in the amount of provision recorded. Thus it would be most prudent for the company to expected cost reduction in the provision recorded pursuant to the fact that the expected cost will decrease by applying technology. Furthermore the standard also requires that a provision must only be used for the expenditures for which the provision was originally recognized. The standard has mentioned three recognition and measurement rules which pertain to future operating losses, onerous contracts and restructuring. IAS 37 states that provisions pertaining to future operating losses shall not be recognized. As far as the onerous contracts are concerned, the present obligations should be recognized and measured as a provision. IAS 37 defines onerous contracts as those contracts which can be cancelled without paying compensation to other party. Moving onto restricting, IAS 37 has laid down certain criteria and requires the companies to record provisions pertaining to restructuring only when all of those criteria are fulfilled. The following table highlights the provisioning requirements of IAS 37. (2009, p 1899) [2] For each class of transactions - Carrying amount - additional provisions made during the period - Amounts used during the period - unused amounts reversed - the increase during the period in the discounted amount For each class of provision - A brief description of the nature of the obligation - an indication about the amount or timings of those outflows - the amount of any reimbursement Comparison with the US GAAP  Under US GAAP, there are no single standard which deals with the accounting and measurement of provisions, contingent assets and liabilities. The general recognition and measurement criteria remain the same under US GAAP and IFRS US GAAP IFRS Discounting provisions As per the US GAAP, the provisions may be discounted when the entity determines that there is a possibility that the timing of payments are fixed or can be determined reliably or when the obligation is a fair value obligation. The GAAP requires the entity to use a discount rate which is dependent upon the nature of provision. As per IAS 37, the provisions should be recorded at their present value taking into consideration the time value of the money. The discount rate is not dependent on the nature of the provisions rather it usually the pretax cost of capital of the company. Measurement of provisions — range of possible outcomes US GAAP requires that the most likely outcome within a range must be accrued. In case where no one likely outcome is probable than the other, the provision is recorded at the least amount. As discussed earlier, IAS 37 requires that the best estimate of the obligation must be accrued. Where there number of possible outflows are involved, the provision is recorded at a mid-point value rather than at the least amount. For any obligation, the best estimate is the most likely outcome but still other possible outcomes should still be considered. Restructuring costs As per US GAAP ASC 240, when the management has committed to a detailed exit plan, each type of cost is examined in order to determine when it will be recognized. For example involuntary employee termination costs are recognized over the future service period whereas all the other costs are incurred when incurred. As per IAS 37, once the management has decided that it is committed to a detailed restructuring plan, all the provision of IAS 37 pertaining to provisioning shall apply. Disclosure of contingent liability US GAAP has no such provision for reduced disclosure as mentioned in IFRS. IAS 37 allows including reduced disclosure of contingent liability if there is a possibility that the comprehensive disclosure would be severely prejudicial to an entity’s position in a dispute with other party. [4] Example from annual report [5] The above extract of the financial statement has been made from the annual report of Barclays PLC ( 2011, p 246), one of the most renowned and prestigious global banks. The above extract is a good example of how companies apply the requirements of IAS 37 in recording provision in their financial statements. As apparent from the disclosure, the bank has recognized provisions in respect of onerous contracts, redundancy and restructuring cost, guarantees, litigation and sundry provisions. The bank has also complied with all the applicable disclosure requirements pertaining to recording provisions. The additions represents the additional provisions recording during the financial year 2011 base on the best judgment of the management at the financial year end 2011, whereas, the amount utilized represents the amounts utilized against the expenses for which these provisions were initially recorded. Exchange movements represent the impact of exchange rate movement in respect of liabilities linked to any other foreign currency. Contingent liabilities are off balance sheet items which means that they are not presented anywhere in the balance sheet of the company but are disclosed in the notes to the financial statements in order to enlighten the user about the probable out flow of economic resources in the future. Discussion The objective of IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ is that appropriate measurement criteria is applied on contingent assets, contingent liabilities and provisions. The International Accounting Standard Board (IASB) is working diligently towards introducing more and more appropriate changes in the standard in order to make it apt and compelling the corporation to disclose all contingent transactions and their outcomes transparently. The board is making such effort to bring into the notice of the user of the financial statement the expected future outflow and inflow of economic resources from the entity. It is also their motive to inform them about the expected financial outlook of the corporation in the coming future and whether it would be able to continue as a going concern or not. As per the Securities and Exchange Commission of US, they are considering to implement the IFRS into US financial reporting system < http://www.pwc.com/us/en/issues> and the board is currently working on identifying the similar and dissimilar accounting treatments between US GAAP and IFRS. [6]. As per the newsletter on Deloitte’s Global webpage The SEC has given particular attention to the requirements in US GAAP ASC-450 and is planning to further modify the disclosure requirements as per that particular US GAAP an brining in line with that of IFRS.[7] As per the announcement on its website, The current development status of the standard pertaining to provisioning IAS 37 is that the IASB (International Accounting Standard Board) is working to update the standard which will, primarily, align the requirement of recording costs of restructuring activities with those in the US GAAP and will provide more specific requirement on measuring the liabilities within the scope.[8] References [1] Deloitte, IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, viewed 5th April. 2012. < http://www.iasplus.com/en/standards/standard36> [2] International Accounting Standards Board, IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, International Financial Reporting Standards, IASC Foundation Publication Department, United Kingdom [3] International Accounting Standards Board, IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, International Financial Reporting Standards, IASC Foundation Publication Department, United Kingdom [4] Ernest & Young, Provisions and Contingencies US GAAP Vs IFRS: the basics, viewed 5th April. 2012. < http://www.ey.com/US/en/Services/Assurance/Accounting-and-Financial-Reporting/US-GAAP-vs--IFRS--the-basics--March-2010---Provisions-and-contingencies> [5] Barclays Plc, Annual Reports, viewed 5th April. 2012. [6] PricewaterhouseCoppers, IFRS and US GAAP: similarities and differences, viewed 5th April. 2012. [7] Deloitt, Financial Reporting Alert 11-1, SECs Focus on Compliance With Loss Contingency Disclosures, viewed 5th April. 2012. [8] IFRS Foundation, Liabilities - amendments to IAS 37 (Paused), viewed 5th April. 2012. Read More