Provisions - Contingent Liabilities and Contingent Assets

Question: Discuss about theProvisions, Contingent Liabilities and Contingent Assets. Answer: Introduction The main purpose of IAS 37 was to ensure that appropriate recognition criteria and proper measurement values are applied while determining the provisions, contingent assets and contingent liabilities. Part A: Definition of Provisions IAS 37 has defined provisions as liabilities that are recognized as balance sheet items and they arise due to presence of uncertain timing and amount. The word provision is also used in context of depreciation, doubtful debts, and impairment of assets. In this standard there are no such connections of provisions created for depreciation, doubtful debts and impairment of assets. According to this accounting standard liabilities means a present obligation of the organization that arises from the past occurrence of any event and outcome of this event is outflow from the entity (Mirza, Orrell and Holt, 2010). As per IAS 37 provisions should be recognized when all the following conditions are fulfilled: When the organization has current or present obligations (either legal or constructive) due to occurrence of past event When there is probability that there will outflow of resources creating some economic benefits are required to be used to settle the obligation. When reliable and meaningful estimates can be made for the provisions to be recognized as the balance sheet item When all of the above conditions are fulfill, than there is requirement to make the provisions in the balance sheet, if not than there is no requirement to create the provisions. Part B: Disclosure Requirement of Provisions IAS 37 has provided various disclosure requirements for provisions, contingent liabilities and contingent assets. These disclosure requirements are mandatory and have to be followed by all. Disclosure requirements for provisions are provided in paragraph 84 of IAS 37. For each class of provisions an organization has to disclose following: The carrying amount of provisions at the beginning and at the end must be disclosed in the balance sheet Any additional provisions made between the periods referred in the balance sheet and also disclose any increases to the existing provisions Any amount of provisions used i.e. charge or incurred against the provisions during the referred period Any amount of unused provisions reversed during the period Any increase in the discounted items that have arise due to the passage of time difference during the period Any change in the discount rate must also be disclosed (Alexander and Archer, 2008) Any comparative information is not required to be disclosed for the provisions. For each class of provisions an organization must disclose following: A small description of the nature of the obligation being created and expected time when it results in the outflows of resources An organization must indicate the uncertainties in relation to timing and amount of the resultant outflows. It must be noted that if necessary an organization must provide proper information and also provide the major assumptions made in relation to future events The amount of the expected outflow of reimbursement and also state the amount of asset that have been recognized for that expected reimbursement (Alexander and Archer, 2008) Part C: Accruals, Prudence and Materiality IAS 37 is drawn in such a way that it confers with the principle of accruals, prudence and materiality. These are explained in detail below: Accrual Concept: According to this principle different income and expenses items in the financial statements must be recognized in the period for which they relate not on the cash basis. Provisions are referred to the uncertain liabilities as there is uncertainty regarding the amount of future expenditure required to settle the liabilities. Even though provisions are made if there is some probability that such liabilities will require some outflow of resources in future time period. Generally accruals are reported as trade and payable but provisions are shown separately in the balance sheet. Prudence Concept: It is most important accounting principle that requires not overestimating the amount of revenues and underestimating the amount of expenses. According to this principle, while recoding the amount of assets some conservativeness must be kept and never underestimate the amount of liabilities. Provisions are liabilities that require outflows of economic benefits at any future time period but there is uncertainty about the time and amount of liabilities. Except in very rare cases the amount of provisions can be determine through the excepted outcomes in each category of provisions. In extreme rare cases where is not possible to determine the amount of provisions that it can be shown as contingent liabilities outside the balance sheet. Materiality: According to this principle of financial reporting all such information must be included in financial statements that sway the opinion of the financial users. As per the disclosure requirement of IAS 37, provisions need to be shown in the balance sheet. Therefore, provisions fulfil the requirement of materiality (Greuning, 2009). Part D: Contingent Liabilities Contingent Liabilities refers to the possible obligation that are created from any event in the past and its existence will be based on occurrence or non occurrence of one or more uncertain future events and these events are not fully under control of organization. Basically contingent liabilities have not been recognized in the balance sheet (Ernst and Young LLP, 2013). It should be disclosed as required by the paragraph 86 pf IAS 37 unless the probability of an outflow of resources realizing the economic benefits are remote. Part E: Contingent Assets The definition of contingent assets is same as contingent liabilities. According to the definition, contingent assets refers to possible asset that are created from any event in the past and its existence will be based on occurrence or non occurrence of one or more uncertain future events and these events are not fully under control of organization. Contingent assets must not recognized in the balance sheet unless there is virtual certain that some part of income will surely arise in future due to occurrence of an event. In this case recognition of income is certain and it cant be treated as contingent assets. However contingent assets can be shown as notes to accounts if there is any event in future that will provide economic benefits. Conclusion IAS 37 deals with provisions, contingent liabilities and contingent assets. It provides guidelines on how to measure the provisions, contingent liabilities and contingent assets. It also tells on how to recognize the provisions, contingent assets and contingent liabilities in the financial report. References Mirza, A., Orrell, M. and Holt, G. 2010. Wiley IFRS: Practical Implementation Guide and Workbook. John Wiley Sons. Ernst and Young LLP. 2013. International GAAP 2013: Generally Accepted Accounting Principles under International Financial Reporting Standards. John Wiley Sons. Greuning, H. 2009. International Financial Reporting Standards: A Practical Guide. World Bank Publications. Alexander, D. and Archer, S. 2008. International Accounting/Financial Reporting Standards Guide. CCH.