international accounting standard 37 This is a topic that many people are looking for. star-trek-voyager.net is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, star-trek-voyager.net would like to introduce to you IAS 37 Provisions Contingent Liabilities Contingent Assets International Accounting IFRS. Following along are instructions in the video below:
“And welcome to the session. This is professor farhad in this session we would look look at is 37 which covered provisions contingent liabilities and contingent assets this topic is in international accounting as well as the cpa exam. And the acca exam as well as always i would like to remind you to connect with me. Only then youtube is where you would need to subscribe.
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You can supplement your studies with becker before we talk about a is 37. We need to talk a little bit more about liabilities because a is 37 provision and contingent liabilities are form of liabilities so if we don t understand what liabilities are we won t be able to understand what the provisions and the contingent liabilities are so we re going to go back to ias one in the presentation of financial statement and the first thing we need to know liabilities they could be current or non current. So first we need to know what is a current liability. What s a non current liabilities.
Well. What is a current liability. Simply put a current liability is a liability that it s expected to be settled in the normal operating cycle. What does that mean it means within our operating cycle and we re going to assume for the sake of illustration our operating cycle is twelve months or one year.
Okay so as long as you re gonna settle it settle it means either pay it off refinance. It defer it we re gonna settle the slide early within twelve month. And you re holding primarily for trading purposes. It means this liability for operating operating your business.
Expect to be settled within twelve months again. What really matters is your normal operating cycle view. So it s twelve month or you cannot defer it more than twelve or does not have the right to defer it you don t have to write a deferred more than twelve month again what we say twelve month really we mean the operating cycle. But we always assume that the operating cycle is twelve month now compared to us gaap they re very similar in terms how do we define liabilities.
But they differ in few things one is refinancing short term debt okay refinancing short term that may be classified as long term. As the refinancing is completed before the balance sheet. Date. This is ifrs.
What does that mean if you have a short term that if you have a short term loan. But it s gonna be refinance you re gonna replace the stone with a long term loan for that short term loan to be considered long term you have to refinance it before the balance sheet. This is ifrs under us gaap are little bit more flexible under us gaap. You don t have to complete it by the balance sheet date.
Under us gaap. Although. This is not a us gaap course. We just wanna let you know it differed for example.
If this december. 31st is the balance sheet date. If the year end is here and let s assume you re gonna prepare your financial statement on march 1st as long as you can take care of it show that you have the ability or you actually refinance. It all you have the ability.
Then you can crest classify this loan. Under the us gaap under ifrs. Guess..
What we have to refinance here. In this period. Before year end. So that s the difference so here gaap.
They have a little bit more flexibility as long as you can do it before you issue. The financial statements. We can live with that amount payable on demand due to violation of that covenant must be classified as current unless a waiver of at least 12 month is obtained from the lender by the balance sheet. Date.
What does that mean under under ifrs. If there s a violation of the debt. What is a violation of the debt you took out alone the bank or the lender. My impose conditions on you can this condition such as your retained earning has to be maintained at a certain level you cannot pay out dividend.
You have to contain a certain amount of cash. Let s assume you took out a loan on november. 1st. And you borrowed a million dollars.
Okay here comes. December 31st as the year end by december 31st. And this loan was for three years. So this is a long term loan by december 31st.
So then take you very long to month you violated your death covenant you did something and your financial statements maybe you paid out too much dividend and as a result the bank says guess what now this loan. I want i need i need you to pay the whole loan back. Because you violated the debt covenant. Okay.
Now under ifrs unless you can get a waiver. Before december. 31st. Which is the year end you re assuming this is a year.
And you have to get the waiver. Here you have to get the waiver. Here and the waiver has to tell you you have more than 12 months to take care of it in other words fix your retained. Earning whatever you violated okay.
Now under us gaap. A little bit more flexible here. Let s assume you re going to issue. A financial statement.
March. 1st. You still have this time to get that waiver to get that waiver. So they give you more time okay so it may be it might be you you have to obtain that waiver by the issuance of the annual report ok.
We re assuming that s here and december 31st. So they give it a little bit more time bank overdraft or netted against cash of the overdraft from an integral. Part of the entity s cash management. Otherwise.
The bank overdraft is defined as a current liability. Well under us. Gaap bank. Overdrafts are always current liabilities.
So this is basically kind of a comparison between the two. But let s talk about what we need to talk about a is 37 which is provisioned contingent liabilities and contingent assets and this session i will not cover contingent asset. I m gonna break this a is 37 into two parts i will cover that in the next session. But what does it do what does what s the purpose of the ias 37.
It provides guidance for reporting liabilities and assets of uncertain timing amount or existence. What does that mean it means we have a liability. But guess what there s something about the liability..
We are missing what is that something that s missing when are we gonna pay at the timing the amount how much are we gonna pay or whether there s a liability or not okay and those are basically those are the provisions and the contingencies. Which will part which we will talk about shortly. Also it contains specific rules related to what s called an arrest contract which i will talk about this in the next session and restructuring cost. I will talk about this in the next session issues that deals with environmental cost.
Which is environmental liabilities and disclosure how much do we need to disclosure so in this session. I will focus only on provisions and contingent liability. It s kind of do the same in the same boat because they talk about liabilities that are uncertain in terms of time and mount or even existence okay so i asked 37 talks about provision and basically those are liabilities as we set up an uncertain and timing amount or existence now. But the question is doing her what is a liability.
Do we know the the definition of a liable. The basically liability is you have an obligation. This is what a liability is you have an obligation. A present obligation to be more specific you have a present obligation that happens.
Because of a past event. Give you an example you borrowed money from the. Bank you debited. Cash credited notes payable for.
100000 that something happened in the. Past as a. Result. Now you have 100000.
In notes payable and in the future. You have to pay the liability. You have to sacrifice your asset. You have to sacrifice usually paid in cash you have to sacrifice some economic benefit usually you pay your liabilities with cash.
It doesn t have to sometime you have to perform your service and just make sure leon i m just making sure you understand what a liability is so this is what a liability is now a provision when would the provision should be recognized so it s a little bit different than the liability. It s a liability. But it s that it has it has little bit more characteristic to it the entity has a present obligation. Which is again we talked about the present obligation at could be legal like your sign alone or a constructive it could be constructive means you accept that some responsibilities that may that expect that made you have made the other part you have a valid expectation for you to deliver.
So this is what constructive so company. Accept certain responsibilities is thus creating valid expectation for example. If you honor a warranty now you have a constructive liability. Because you have to you have to deliver you have to deliver in case.
Something happen you have to make the product hold for that customer in case. It breaks down you have to you might have to replace it ok also it is probable now probable means more likely than not and how do we define this and we re talking about this is an international accounting. So we re talking about ifrs more likely than not is define basically in the literature. As 50 plus of there s more likely than others more than 50 chance that you re gonna have to pay something in the future.
Then that liability is will have to be i will have to be recognized recognized means recorded. So first you have to have an obligation ok either constructive or legal. The probability of you paying. It has to be just more than 50 now us gaap is a little bit different they want basically higher probability.
And the third component is we have to have a reliable estimate you have to know how much you are gonna be paying or you can estimate how much you re gonna be paying. Now you might be saying what happened if the probability is that if it s probable less than 1 less than 50 less than 50 means. It s as far as irs it s not likely than not you re not gonna pay okay we re gonna talk about this well but those are the three conditions 1 2. 3.
To have a provision to record the provision and what does it need to record the provision generally speaking to debit either in expense or loss. Most of the time and credit a liability. So you have a provision you have a provision you have a liability and basically for to pay something 10000. You debit expense or a loss and you credit the liability.
I m gonna be responsible for that why because there s more than 50 and chance i m responsible for this and i can estimate the standard hour. How do you know if you have a provision when you ask yourself can you avoid this obligation. If you cannot avoid the obligation. Then you have an obligation.
Okay. Now those are provisions. What are contingent liabilities..
Because. I told you that kind of the same thing. Okay the possible obligation that arises from a past event whose existence will be confirmed by the occurrence or non occurrence of a future event. So basically simply put something happened in the past and we re waiting for the future to see if that if the liability will mit.
Will occur or not the best. The an a classic example is a lawsuit someone someone sue s you that s a contingent liability. Why because you might lose the pending on the outcome by the judge and the jury okay or contingent liability. Exists.
When you have a present obligation. That is not recognized you cannot recognize it why can t you not recognize it because it s not probable. How do we define probable less than 50 that an outflow of resources will require to be settled or you cannot measure the amount that you have to pay so you do have you don t have a liability. It exists.
But here s the problem. There s less than 50 chance or if there s more than 50 chance. But you don t know the dollar amount. Why don t you why don t you know the dollar amount.
Because the case is so unique and all depends on the jury. The jury could award the plaint cudworth the plaintiff a dollar or they could award them. 1000000. You really cannot make any estimate under those circumstances you have contingent liabilities.
So basically provisions let me just show you this picture. Although i use this one. I i teach us gaap. But this is basically i can use this for ifrs as well so what s gonna happen is you have to you have to you have to guess or the company will have to estimate or studied or probability of losing if they are being sued the probability of losing if usually let s start with remote remote means.
There s no chance or a very low chance. Okay basically we can ignore the situation. Okay. Now if it s under our new us gaap first let me just explain us gaap under the us gaap if there s remote chance you re gonna lose you ignore the situation if it s reasonably possible now you re a scab does not give you a percentage for reasonably possible.
But they say there isn t it possible reasonably possible means it may or may not happen we re not really sure what you need to do you need to do a footnote footnote means you need to disclose it disclosing means. What means you tell the in the financial statement. You tell us you re being sued by such and such party. And here are the merits of the case.
It s in in a federal state. Whatever court that is in it s going to take us three years to resolve this issue and just be aware of it okay we disclose. It now if it s probable now us gaps as probable has to be like 70 to 98. Like really.
There s a high chance you are going to lose okay if you ever if there s a high chance you are going to lose that s not enough you accrue. Only if you know the dollar amount. So there s a it s a probable and you know the dollar amount the from plus the dollar amount then you accrue accrue means you would recognize so this is us gaap okay. I m gonna use a different color.
If you don t know the dollar amount you just disclose. I m gonna use a different color to illustrate ifrs ifr. I simply put simply put if it s less than 50. Let s assume the 50 level here.
That s less than 50. Okay. You can disclose basically you could put in the notes. Once it s more than 50 end.
And you can estimate then you would recognize so notice the threshold is lower 50 plus and you know the dollar amount. You will you would record okay. So it s anything less it s a contingent liability and you will disclose in the nose. Now the question becomes how do you measure how do you measure the dollar amount.
What s the estimate because you re estimating well the best estimate. Okay. It s how much it s gonna cost you to settle it on the balance sheet..
Date. That s the best estimate now how do you of course. That s the best estimate now how do you do it well one way to do. It is to do a probability weight expected value.
What does that mean let s assume. There s a you know 10 percent chance you would lose a hundred thousand there s 20 percent chance you would lose 300000. So on and so forth. So you ll add up all your percentage 100.
Percent. And you will take ten percent times. 100 thousand that s ten thousand twenty percent times three hundred thousand if my math is right. It s sixty thousand and you add up all the probabilities.
And that s the expected okay so this is the best value is the probability weighted expected value within a range of estimate. This is an estimate or the midpoint if all estimates are equal. We are equally likely you know if you have. Two numbers it s.
Either 50000 or. 100000. Well let s split the. Difference.
75000. Now also the provision must be discounted. If you expect to be paying this three years from now you will discount it to the present value and provisions must also be reviewed at the end of each accounting period and adjusted to reflect current best estimate. So if this is what you estimate that now and next year.
There s more evidence to the case and now they re gonna up the up the settlement. Then guess what you re gonna have to change that as well the best way to do this is just to look at an example to see how this all work. A former employee of this company filed a lawsuit against the company in year one for age discrimination. December 31st.
The external legal counsel provide an opinion that it s 60 probable there we go more than 50 percent. That the company will be found. Liable which will result in a total payment between a million and 15 million in those equally likely 50 chance a million 50 percent chance of 15. Month.
Because it s more likely than not the hero. How more likely than not sixty percent and we know the dollar amount and we know it s fifty percent a million fifty. Percent. 15 million guess what now we have a liability of 125 125 million therefore we debit litigation loss we credit provision for litigation now under the us gaap.
I m telling you under us gaap. We don t do this why under us gaap. We don t do this because 60 percent is not high probability under us gaap or just disclose that we are being sued by this individual. And that s the end now what happened when we actually paid the sly ability.
Because eventually. We re gonna have let s assume we paid it and that s we. Settled. For 1000000 we settled for.
1000000. Therefore we have to credit cash a million if we settle for a million we have to debit this the provision for laws. We have this is a liability we have to debit this provision for law for four laws for litigation laws. Which is a liability 1 million.
Two hundred and fifty in that we have to do we have to reverse litigation laws we have to basically credit reversal of litigation loss which is gonna increase our income for a year when we pay it so this is here when we pay it the zr1. It s gonna increase her income by two hundred and fifty thousand if you have any questions about this topic please email me if you happen to visit my website please consider donating if you re studying for europe cpa exam or your certification study hard. It s worth it in the next session. I would take a look at those topics.
Which is part of ” ..
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