ACCA FR/F7, Ulitimate Guide-Provision,Contingent Asset & Liabilities – IAS 37
Accounting Before IAS 37
Before the introduction of IAS 37 in the financial world, businesses faced problems recognizing and reporting contingent assets, contingent liabilities, and provisions. The absence of regulations and suggestions caused great outcomes for studying monetary statements. This erodes the belief of international investors to invest money in various entities.
Introduction to IAS 37
In this environment of ambiguity, IAS 37 was introduced, which gives a signal and sets the guidelines and basis for the measurement and recognition of provisions, contingent liabilities, and contingent assets. IAS 37 was introduced in 1998 by the International Accounting Standards Committee.
Understanding IAS 37: All You Need to Know
IAS 37, issued by International Financial Reporting Standards (IFRS), gave guidelines and measurement criteria for provisions, contingent assets, and contingent liabilities. Let’s delve into some of the key terms:
Provisions are liabilities of uncertain timing or amounts, according to IAS 37. These are the amounts set aside in the prediction of future expenditures. IAS 37 provides the criteria for the recognition of provisions. The measurement criteria include:
- Provisions should be recognized when the entity has a present obligation. The present obligation is either legally or constructively a result of past events. Legally, which is enforceable by law or statutory requirements. A constructive obligation can be a result of an entity’s past practice or any policies. They are imposed by law. A constructive obligation arises when the customer has expectations from his supplier.
- An example of a constructive obligation is that if ABC Company has a practice of refunding customers for defective products, it may have a constructive obligation to continue this practice. Companies should carefully determine whether the criteria for provisions are according to IAS 37 or not.
- The second recognition criterion is probable outflow. In accounting language, probable means when there is more than a 50% chance that an outflow of resources will be required to settle the commitment. To make it more clear, companies have to use their assets or the source of economic benefits to fulfill their obligation.
- The last condition for provisions is a reliable estimate. It must be met to recognize provisions correctly and precisely. A reliable estimate means the company managers can decide the appropriate amount to settle the liability. The company can use all the available information to decide the amount. Reliable estimates should be calculated by using the probability of all possible outcomes. To sum up, a reliable estimate requires evaluation to know the financial amount needed to settle the obligation.
Thus, if companies meet these conditions for the settlement of provisions, there will be more accuracy in their financial statements. It will lead to more clarity. Companies can do better strategic planning by applying IAS 37.
For some ACCA candidates, specific IFRS® standards are more favoured than others. IAS® 37, Provisions, Contingent Liabilities and Contingent Assets appears to be less popular than other standards because, usually, answers to Financial Reporting (FR) questions require a balanced discussion of whether criteria are met, as opposed to calculating numbers. However, IAS 37 is often a key standard in FR exams and candidates must be prepared to demonstrate application of the criteria .read more
Contingent liabilities are liabilities that have the capacity likely to occur in the future. Contingent liabilities should be recorded to make sure the financial statements are accurate and completely follow the guidelines of IFRS.
- A present obligation, For contingent liability, there must be a present obligation resulting from any past events. The obligation can arise from any legal actions taken, contracts for payment to a supplier, or a warranty.
- The likelihood of an outflow of resources is low; it is not probable that an outflow of assets will be required to settle the liability. Probable means that the chances are greater than 50% that an outflow of resources will be required to settle the liability. Companies should assess all the evidence and information related to contingent liability.
- Reliable estimate: the amount of the obligation cannot be measured reliably. Contingent liabilities are not recognized in the financial statements.
- Remote contingent liabilities are not disclosed in the financial statements because their likelihood of occurrence is improbable.
- Possible contingent liabilities are those that, when there is some uncertainty, are also not recognized in the financial statements. However, they should be disclosed with financial effect to inform company owners about the prospective risks.
Contingent liability examples include product damages, the warranty of products, lawsuits, and pending cases.
To wrap up, contingent liabilities should not be recognized in the financial statements; they should be revealed in the notes. Disclosure and recognition depend on their chances of occurring. Remote liabilities should never be disclosed or recognized. Only the possible one is to be disclosed in the notes.
A contingent asset is an asset that has the potential to generate economic well-being for the company in the upcoming times. IAS 37 has also provided the measurement criteria for the recognition of contingent assets. Let’s read out some points to understand contingent assets:
- Contingent assets are uncertain. This means they live in a state of uncertainty. Their occurrence or non-occurrence depends on future events.
- For contingent assets, there are recognition criteria. If it is probable, it will not be recognized in the financial statements but will be disclosed in the notes to the financial statements when the company knows that the inflow of economic benefit has a greater than 50% chance.
- If the inflow of economic benefit is virtually certain, that means closer to 100%. This indicates the occurrence of uncertain events are likely to happen. In this case, IAS 37 allows the organization to recognize these assets in the statement of financial position.
- If the amount is virtually certain, the amount of the asset should be measured. The organizations should make a reliable estimate of the asset’s value.
- Examples of contingent assets include: Legal claims, If the company is involved in any legal matter and if the company knows the decision will be in the company’s favor, the settlement amount will be considered virtually certain and recognized as an asset. A company named BJF has an asset with a probable tax refund of $20,000. This asset constitutes the predicted return from overpaid taxes, with a 75% chance of approval by tax authorities. Since the chances are probable, BJF should disclose the contingent asset in their financial statements.
Remember, businesses that don’t apply for IAS 37 may face some consequences. The investor’s belief relies on true and accurate financial statements. This may decrease their investors’ confidence. There is a regulatory risk when not applying IAS 37, which may lead to some penalties or fines.
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International Accounting Standard (IAS) 37 plays an essential part in the financial world. It is a set of guidelines or a framework that tells an organization how to measure, disclose, and recognize provisions, contingent liabilities, and contingent assets. Its significance extends beyond the domain of accounting because it plays a vital role in promoting transparency, accountability, and other good components.
Frequently Asked Questions FAQs
How does IAS 37 shape the accounting landscape?
Consistency, When IAS 37 came into the accounting world, it provided a standardized framework that made sure every company and the entities of every country applied similar principles. Today, IAS 37 is adopted by many countries around the world. This stability investor confidence.
The prudential concept in IAS 37 also encourages prudent accounting in the way that liabilities are recognized when the chances are probable, uncertain timings, or uncertain amounts. This practice prevents the minimization of financial statements.
Compliance with legal laws, One benefit of IAS 37 is that companies comply with legal regulations. It also ensures compliance with the International Financial Reporting Standard (IFRS), which helps them in many ways and thus lowers the risk of legitimate arguments.
Corporate governance, This framework of IAS 37 aligns with the principles of corporate governance, which include accountability, transparency, and reliable financial statements. Therefore, IAS 37 advances trust in financial statements.
Where can I find additional study resources or examples to improve my understanding of this topic?
Look for ACCA study materials, textbooks, and online resources to find more examples and exercises to strengthen your knowledge of provisions, contingent assets, and contingent liabilities. If you are a Mirchawala student contact us and we will assist you further