IAS 37 Problems and future developments

Module No: 7BSP0381 Advance Financial Reporting

Student Name:

ContentsIntroduction................................................................................................................................................3

Initial Recognition.....................................................................................................................................5

Subsequent measurement......................................................................................................................5

Problems and possible solutions............................................................................................................6

Reference..................................................................................................................................................7

Introduction

Liability in the financial statement attracts much attention than other financial statements items such as assets and equity as it shows the company’s present obligations. As per the Framework for preparation and presentation financial statements published by international Accounting Standard Board (IASB) liability is defined as a present obligation of company which resulting from a past event and settlement of such obligation may result in a out flow of resources that have economic benefits.

Further the framework discusses the need for the distinction of the present obligation which leads to liability and a future commitment which might be a contingent liability in the financial statements.

The IASB has introduced several standards which are dealing with different types of liabilities. Those are,

IAS 19 Employee benefits IAS 32 Financial Instruments - presentation IAS 39 Financial Instruments – Recognition and measurement IFRS- 2 Share Based payments IFRS 7 – Insurance contracts

Due to the complexity involved in recognition and measurement of liabilities other than those covered from above mentioned standards, IASB introduced a new standard IAS 37, Provisions, contingent liabilities and contingent assets where it requires to identify certain liabilities as provisions and contingent liabilities.

However such standard contains several confusions when applying the provisions of the standard. Mainly there are two complicated and vague areas in IAS 37. Those are,

As per the provision of IAS 37, an entity needs to recognize a provision in its financial statements at the best estimated amounts. However the standard fails to give proper guidance as to the meaning of best estimate. The standard explain best estimate as the amount that is required to settle the present obligation as of the balance sheet date.

However due to the uncertainty and other factors such as the judgment and the experience of the management the best estimate may be change in different circumstances and the provision amount also may change in the financial statements.

IAS 17 does not provide proper guidance as to what kind of costs needs to be included in when measuring liabilities. Thus some entities include only the direct costs applicable

to such liability while some entities use only the incremental cost. Further some entities consider indirect cost as well in measuring liabilities. Moreover some entities measure the liability based on the amount that they needs to pay for a contractor to fulfill the obligation.

IAS 37 – Provisions contingent liabilities and contingent assets was developed by IASB by a joint project with ASB in 1998. Subsequent to the standard the IASB released several interpretations to IAS 37, those are

IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities IFRIC 3 - Emission Rights (Withdrawn in June 2005) IFRIC 5 - Rights to Interests arising from Decommissioning, Restoration and

Environmental Rehabilitation Funds IFRIC 6 - Liabilities arising from Participating in a Specific Market – Waste Electrical and

Electronic Equipment( http://www.iasb.org)

After those interpretations it was understood that the initial standard needs to be modified to suits for the liabilities arises from modern business transactions. Thus IASB issued a Exposure draft for IAS in several times and in 2010 finally.

The objectives of the exposure draft is as follows,

To align the criteria in IAS 37 for recognizing a liability with those in other IFRSs. To remove some differences between IAS 37 and US Generally Accepted Accounting

Principles (GAAP) To Clarify measurement of liability in IAS 37 further

(http://www.iasplus.com/agenda/converge-ias37.htm#ed)

It can be noted that the guidance given in the standard with regard to measurement of provisions contingent liabilities and contingent assets is not clear and gives vague conclusions. For example the standard suggest various ways in dealing for uncertainty when making provisions such as

expected value (or probability-weighted) method mid-point of the range of possible outcomes estimate of the individual most likely outcome

Those method suggested by the standard include lots of problems where the possible outcome may be misstated.

Due to the various issues and concerns of the users of the financial statements and companies IASB took steps to issue an exposure draft with the intention of addressing such concerns. Accordingly first exposure draft was issued in 2005 and with the proposals of several parties it was reissued in 2010.

As per the exposure draft issued by IASB in 2010 there are several differences when measuring liabilities when compared with existing IAS 37,

Initial Recognition

IAS 37 proposes the provision amount that is recognized as liability is recognized at the best estimate amount.However the exposure draft for IAS 37 proposes that the liability in the financial statements to be recognized on the basis that the amount that the entity will pay rationally at the end of the financial period to settle such obligation.Further it provide guidance that the amount rationally pay would be lower of

o The present value of the cash or other resources that needs to utilize to settle the obligation in future.

o The amount that the company may have to pay if the obligation is cancelled.o The amount that the company may have to pay if the obligation is transferred to a

third party.It can be noted that there is a significant different between IAS 37 and IAS 37 exposure draft with regard to the measurement of liabilities. Accordingly the IASB s view on liability seems to be changed significantly through this exposure draft.

Further in the exposure draft it gives separate and clear guidance as to the determination of present value of resources, how to determine the cost of cancellation the obligation and the amount needs to pay when transferring the obligation to a third party.

Subsequent measurement

When considering the subsequent measurement IAS 37 does not provide proper guidance as to how the entity should subsequently measure the provisions and contingent liabilities.

However IAS 37 exposure draft states that the company needs to make adjustments to the carrying value of liabilities which recognized at the initial point at each financial reporting period based on the amount that the company rationally pays to settle the obligation as of such date.

The resulting amount needs to be recognized to the income statements as a part of the borrowing cost.

Apart from IAS 37 in some instances IASB proposes different measurement basis for different types of liabilities. As provided above different standards provide various measurement bases making recognitions of liability being a complex area. Among other liabilities in IAS 19, Employee benefit the IASB guides the post employee benefit liability to be measured using projected unit credit method which is an actuarial valuation technique.

Problems and possible solutions

Thus it can be noted that providing guidance for measurement and recognition of liabilities in the financial statements is a challenging task to IASB. The main reason for such problems are complex business transaction taken place in the business world in the modern business environment for which IASB has not been able to address properly. Moreover the expectations of the user groups of financial statements has not been properly identified when developing standards relating to liabilities and thus such standards needs to be change to full fill those expectations.

In order to overcome from such problems IASB can use following actions.

IASB can start a useful and effective discussion with the user groups of the financial statements and should identify the expectations of those parties. Thereafter Guidance for recognition and measurement of liabilities needs to be build up to suit for those expectations as well as substance of those business transactions.Further exposure drafts needs to be opened for more discussions among the users of the financial statements. More specifically attention of professional firms and academics needs to be obtained where practical knowledge and theoretical aspect can be discussed

Apart from those attention needs to be given to the current business and economic trends prevail in globally and how those factors affect to the ways in which financial reporting is done.

By applying discussed recommendations IASB will be able to address to measurement and recognition problems for liabilities in the International Financial Reporting Standards.

Reference IASB,2010, Exposure draft ED/2010/1,IASCF IASB,2001, International accounting Standards 37 Provisions Contingent liabilities and

contingent assets, IASCF IASB 2012, International Accounting Standard Board, United kingdom, <

http://www.IFRS.org/> viewed on 29, March 2012.

Ernst & Young 2012, Ernst & Young LLP 2012, united kingdom, < http://www.ey.com/>

viewed on 30, March 2012.

Deloitte global services limited 2012, Deloitte global services limited, United Kingdom, <

http://www. iasplus, com/> viewed on 30, March 2012.

Gee Paul, Alan Sugden, Interpreting Company Reports 10 th edition, 2008, Pearson

Education.

ICAEW 2012, ICAEW, United Kingdom, < http:// www. ICAEW. org/> viewed on 20,

March 2012.