Due to globalization in the recent past, the world has become a global village. Many multinational companies have started expanding their business across various countries. Accounting frameworks of different countries provide different accounting treatment, which has resulted in confusion in the minds of users of financial statements. IFRSs (International Financial Reporting Standards) are the globally accepted accounting standards and principles. Hence, with a view to enhance the acceptability of financial statements of Indian companies, the new Indian accounting standards have been issued in order to ensure convergence with IFRS. The existing accounting standard AS29 and the new Ind AS 37 deal with Provisions, Contingent Liabilities and Contingent Assets. However, there are certain new issues and rules laid down in Ind AS 37, which were not earlier specifically mentioned in AS29.
Key provisions in Ind AS 37 are as follows
1. A provision should be recognized when:
a. An entity has a present obligation (legal and constructive) arising out of a past event.
b.It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
c. A reliable estimate can be made of amount of the obligation. The word 'probable' is interpreted in this standard as 'more likely than not' i.e. probability of occurrence of such obligating event being more than 0.5.
2. A contingent liability is a possible obligation (probability of occurrence being less than 0.5) and its occurrence is confirmed by occurrence or nonoccurrence of one or more future uncertain events not wholly within the control of the entity.
However it cannot be provided for because It is not probable; or A reliable estimate cannot be made. A contingent liability is not recognized in books of accounts. It is disclosed by way of a note unless the probability of its occurrence is remote.
3. A contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or nonoccurrence of one or more future uncertain events not wholly within the control of the entity. Ind AS 37 requires disclosure of contingent assets if occurrence of such assets is probable. A contingent asset is not disclosed in the financial statements. It is usually disclosed in the report of approving authority.
4. Where some or all of the expenditure required meeting provision is expected to be reimbursed by another party, the reimbursement should be recognized only when it is virtually certain that reimbursement will be received if the entity settles the obligation.
5. Restructuring provision is recognized only where the recognition criteria for provision is met. Provision for restructuring costs shall be with respect to direct costs related to restructuring only i.e. not related to ongoing operations of the enterprise However, restructuring provision does not include costs such as Marketing, Retraining or relocating training staff etc.
6. Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate.
7. Loss on Onerous contracts shall be recognized as soon as such contract is identified.
Newly introduced / modified rules with regard to provisions, contingent liabilities and contingent assets as per Ind AS 37 are
1. Definition of obligating event has been modified to include even constructive obligation. Constructive obligations are more or less like self-induced obligation whereby an entity desires to create provision out of normal business practices, custom and a desire to maintain good business relationships or to act in an equitable manner.
E.g.: If TATA group goes about mining in a piece of land hoping to find some mineral ore, after such activity, it will try to bring back such land to normalcy, so that it's goodwill will not get affected. TATA group would do so even if there were no legal obligation. This sort of obligation is constructive obligation.
2. AS 29 has laid down that provision for losses till the date of restructuring of a business shall not be provided. Ind AS 37 has also given the same rule with exception of loss on onerous contract.
3. Onerous contracts: These are the contracts where cost required to fulfill the contract is much higher than economic benefit to be obtained from it. As per the provisions laid down in Ind AS 37, loss on onerous contracts shall be provided for as soon as they are identified. Amount of provision would be the 'Cost of fulfilling the contract' or 'the penalty or compensation amount to be paid to terminate the contract' whichever is lower
4. Concept of discounting with respect to provision is required by Ind AS 37 if time value of money is material. Discount rate shall be pre-tax risk free rate i.e. Government bond rate.
E.g. while finalizing the accounts for financial year 2015-16, X ltd. is anticipating a settlement for a claim amounting to INR100 lacs to be paid in the year 2020. Applicable discount rate is 3%. Compute the amount of provision to be created as per provisions of Ind AS 37. Solution: As per the provisions laid down in Ind AS 37, discounting is required with respect to provision if the time value is material. Assuming so, amount to be provided would be Discount factor at 3% for 5th year * INR100 lacs = 0.862*INR100 lacs = INR 86.26 lacs
However, if the same question is to be answered as per AS 29, answer would be different. AS 29 does not require the discounting of an amount to be settled on a future date. Hence as per AS 29, it would be legitimate if the company provides for INR100 lacs.
5. Disclosure is required with respect to contingent asset in the financial statements if its occurrence is probable. However, AS 29 provides only for disclosure in the reports of approving authority.
6. Appendix of Ind AS 37 provides guidance on matters regarding a. Decommissioning costs
a. Decommissioning costs
b. Environmental rehabilitation funds
c. Liabilities arising from participating in specific market- waste electrical and electronic equipment.
d. Levies imposed by government.
AS 29 does not provide such guidance.
The author can also be reached at raghuveerteja@gmail.com
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