The International Accounting Standards Board (IASB) is in the process of reviewing IAS 37 in order to improve the guidance on identifying liabilities, reduce differences between IAS 37 and U.S. GAAP, make the recognition requirements for liabilities in the scope of IAS 37 consistent with those for other liabilities, and clarify the requirements for measuring liabilities. The IASB plans to complete the standard during 2010, so it will be important to monitor the changes.
IAS 37 is very comprehensive, and for the purpose of this article, only a high level summary is possible. As always, it is important to read and understand the details of each IFRS standard.
IFRS has one standard for provisions – IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, and is a “principles-based” standard. Under Canadian GAAP there is less guidance, and although one related source is CICA 3290 – Contingencies, accountants typically fall back on the fundamental definition of a liability.
The difference between IFRS and Canadian GAAP will depend on the type of provision being considered. Differences may arise in both recognition and measurement of provisions.
Recognition of a provision is based on the probability that you are going to make a payment, or deliver some other asset to fulfill the obligation. Under Canadian GAAP, a provision is based on the “likely” probability that a payment will be required. In comparison, provisions under IFRS are based on a “more likely than not” probability. “Likely” is often taken to be a different and less stringent threshold and therefore it is anticipated that there will be additional provisions under IFRS as compared to Canadian GAAP.
Another important IFRS distinction for provisions is the notion of “constructive obligations” – which are not necessarily legal, but rather where valid expectations have been created to settle an obligation. As an example, a company causes damage to be done to the environment and it needs to be cleaned up. The company commits to the restoration, and this is communicated to external stakeholders. This in turn has created a valid expectation to incur clean up costs among third parties – therefore this is a “constructive obligation”.
Under IFRS, the degree of uncertainty of an obligation (either legal or constructive) determines the manner in which the obligation is categorized and reported for financial reporting purposes.
Obligations with a high degree of certainty would be recognized and reported as payables and accruals. This would include legal obligations such as trade payables, and constructive obligations such as unpaid holiday bonuses which were promised but not yet paid.
Obligations with a lower degree of certainty, but likely, would be recognized and reported as provisions. This would include legal obligations such as a contested lawsuit that will probably require payment, and constructive obligations such as announced warranties beyond contractual rights.
Obligations with a low degree of certainty, and unlikely, would be disclosed as a “contingent liability” in the footnotes of the financial statements, and would not be recognized. Note the significant difference in the definition and reporting regarding contingent liabilities between IFRS and Canadian GAAP.
Terminology and measurement may be different between Canadian GAAP and IFRS, so these standards must be reviewed carefully.
In addition to the classification of obligations by degree of uncertainty, there is also a criterion for recognition that requires a reliable estimate of the amount of the obligation. IAS 37.26 states that the circumstances in which it will not be possible to reach a reliable estimate will be extremely rare. However, if those circumstances exist, regardless of the obligation’s classification, the liability would be treated as a contingent liability and would not be recognized, but disclosed in the financial statements.
IAS 37 also provides practical rules governing the measurement of obligations, particularly under uncertainty. A partial list of these rules includes the following:
• A provision should be recognized at the best estimate or expected value of its outcome. This estimate is the amount that an entity would rationally pay to settle the obligation.
• Where there is a range of amounts, the entity would choose the most likely outcome, or expected value. This would be in contrast to the Canadian GAAP rule where the minimum amount is accrued unless a particular amount in the range appears to be the best estimate.
• Where the effect of the time value of money is material, a provision should be recognized at its present value. The discount rate should be pre-tax, should reflect the risks specific to the liability, and should be adjusted over time.
• Changes in provisions should be recognized at the best estimate as at each statement of financial position date, and the provision can be reversed if it falls below the recognition criteria.
So what does this mean to your organization for the switch to IFRS? At a bare minimum:
• Assess whether any additional provisions exist under IFRS that didn’t exist with Canadian-GAAP:
o Due to the “more likely than not” probability threshold difference.
o Assess whether there are Constructive obligations, in addition to legal obligations.
• Assess whether the $ amount of all provisions under Canadian GAAP is different and adjust any difference.
I hope this helps. This is one of a series of blogs that is meant to convey information relating to Canada’s transition from Canadian GAAP to IFRS.
For further information, please refer to the ongoing series of IFRS blogs on the Edelkoort Smethurst Schein CPA’s LLP web-site and please remember to contact your accounting professional for further guidance.
Edelkoort | Smethurst | Schein CPAs LLP is located in Burlington Ontario servicing the Golden Horseshoe and Greater Toronto Area and beyond. The firm is fully licensed with CPA Ontario to provide assurance, tax and accounting services as well as registered as tax preparers with the Canada Revenue Agency (CRA) & Internal Revenue Service (IRS). The firm is also registered as an IRS Certified Acceptance Agent.
All blog posts published on this site are for informational purposes only and do not constitute professional advice. Readers should contact a professional to discuss their individual situation. Neither the author or the accounting firm shall accept any liability for any reliance placed on the information posted.