Proposed amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets

The changes are related to the present obligation recognition criterion, the costs to be included when measuring a provision and the discount rate to be applied. Under the IASB’s proposal, some provisions could be recognised earlier, progressively and some provisions may become larger.

The business world is a constantly changing environment and companies may face additional challenges when accounting for more complex transactions and uncertainties. The IASB is proposing to amend the present obligation criterion because of the challenges faced by companies in applying the criteria including climate-related commitments, threshold-based obligations and stakeholder dissatisfaction with IFRIC 21 Levies. The proposed amendments are intended to clarify how to determine whether a present obligation exists, when provisions are to be recognised as liabilities and how they are to be measured.

The proposed amendments would replace the requirements in IFRIC 21 Levies, which would be withdrawn. The proposed amendments would supersede the requirements in IFRIC 6 Liabilities arising from Participating in a Specific Market - Waste Electrical and Electronic Equipment, which would be withdrawn.

The three new tests proposed to determine whether a present obligation exists are as follows:

1. Obligation test: Does the company have an obligation?

Under the proposal, the company has present obligation if all three of the following criteria are met:

• Existence of a mechanism imposing a responsibility on the company if it obtains specific economic benefits or takes a specific action
• The company owes that responsibility to another party
• The company has no practical ability to avoid the responsibility if it obtains benefits or takes action.

2. Transfer test: Is the obligation to transfer an economic resource?

• The proposal introduces a new, specific test, which would require a company to assess whether its obligation has the potential to require the company to transfer an economic resource; and the transfer of economic resources is to another party.

3. Past event test: Is it a present obligation as a result of a past event?

• Under the proposal, a company has a present obligation as a result of a past event if it has obtained economic benefits or taken action; and consequently, will or may need to transfer an economic resource.

IAS 37 currently provides no specific guidance on threshold-based obligations and instead, companies apply IFRIC 21. Under the proposal, a present obligation would accumulate as the company carries out the activity linked to the threshold that it expects to exceed at the end of the compliance period. The proposals shift the focus from the threshold being exceeded to the activity the threshold is linked to – e.g. shifting from exceeding the emissions threshold to emitting pollutants. This would also require the management to make new judgements and estimates throughout the reporting period, including whether a threshold will be exceeded.

The IASB further noted that a company applying the proposed amendments would not necessarily recognise a provision before its activity exceeded the threshold. The company would recognise a provision only if the other recognition criteria in IAS 37 were also met, that is if it were probable that a transfer of economic resources would be required to settle the obligation, and a reliable estimate could be made of the amount of the obligation. 

A company would include all direct cost when measuring any provision. This cost would include incremental costs and an allocation of other costs that relate directly to settling the obligation. For example, a company may currently recognise a provision for a legal claim based on incremental costs only. Under the proposal, the company would need to include all direct costs, such as the internal legal team payroll and an allocation of other costs. Companies may require new processes to identify all direct costs and an allocation method.

The IASB proposes to use a risk-free discount rate in measuring a long-term provision. It would make no further adjustments – for example for non-performance or own credit risk. The proposed amendments to the discount rate are aimed at reducing diversity in the discount rates that entities use when measuring provisions. This would increase the transparency and comparability of the financial statements. The proposal may cause some provisions to become larger – for example – those currently measured at risk-adjusted discount rates. They could also cause provision amounts to become material and require recognition.

The proposals are likely to be particularly relevant for companies that have high long-term obligations to dispose of assets or are subject to levies and similar government-imposed charges. The impact of these changes could be significant for some companies depending on the nature of their obligations and their existing accounting policies. This would require management to make new judgements and estimates throughout the reporting period, including whether a threshold will be exceeded. The proposals may result in larger provisions at an earlier date.

Companies should consider the proposal and assess their potential impacts. The IASB will consider comments it receives on the proposals and will then decide whether and, if so, how to amend IAS 37.

To help you assess the impact, please refer to our guide.

Visalakshi Ganesh

IFRS Desk

+358 20 767 2140

firstname.lastname@kpmg.fi