Summary of IAS 37
The objective of IAS 37 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements – planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition.
IAS 37 excludes obligations and contingencies arising from: [IAS 37.1-6]
financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition and Measurement (or IFRS 9 Financial Instruments) non-onerous executory contracts insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other provisions, contingent liabilities and contingent assets of an insurer items covered by another IFRS. For example, IAS 11 Construction Contracts applies to obligations arising under such contracts; IAS 12 Income Taxes applies to obligations for current or deferred income taxes; IAS 17 Leases applies to lease obligations; and IAS 19 Employee Benefits applies to pension and other employee benefit obligations.
Key definitions [IAS 37.10]
Provision: a liability of uncertain timing or amount.
present obligation as a result of past events settlement is expected to result in an outflow of resources (payment)
a possible obligation depending on whether some uncertain future event occurs, or a present obligation but payment is not probable or the amount cannot be measured reliably
a possible asset that 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.
Recognition of a provision
An entity must recognise a provision if, and only if: [IAS 37.14]
a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event), payment is probable ('more likely than not'), and the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37.10]
A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for example, a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period. [IAS 37.10]
A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote. [IAS 37.86]
In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present obligation. In those cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date. A provision should be recognised for that present obligation if the other recognition criteria described above are met. If it is more likely than not that no present obligation exists, the entity should disclose a contingent liability, unless the possibility of an outflow of resources is remote. [IAS 37.15]