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Highlights
As the business world evolves, companies may face additional challenges when accounting for more complex transactions and uncertainties. Accounting for provisions is one such area that has prompted the following long-standing questions.
- How do you determine if a present obligation exists and when do you recognise a provision?
- Which costs do you include in measuring a provision?
- Which discount rate do you use in discounting a long-term provision?
In response, the International Accounting Standards Board (IASB) is proposing to clarify the related requirements in IAS 37 Provisions, Contingent Liabilities and Contingent Assets and withdraw related interpretations, including IFRIC 21 Levies. The proposals may result in larger provisions at an earlier date.
When do you recognise a provision?
One of the challenging questions in applying IAS 37 is when to recognise a provision, specifically how a company determines if it has a present obligation and what a ‘past event’ is. These questions became more prominent with the rise of climate-related commitments and threshold-based obligations.
In response, proposals to amend IAS 37 include:
- three new tests to determine whether a present obligation exists; and
- specific guidance for threshold-based obligations.
What does this mean for companies? The impacts of these changes could be significant for some depending on the nature of their obligations and their existing accounting policies.
Under the proposals, companies may need to start recognising some provisions sooner if they expect to exceed a specific threshold. This would require management to make new judgements.
Which costs do you include in measuring a provision?
IAS 37 provides no specific guidance on which costs to include in measuring a provision. Therefore, companies’ approaches vary depending on the nature of the provision and their accounting policy.
The IASB proposes to include all direct costs in measuring any type of provision. This may result in some provisions becoming larger.
For example, a company may currently recognise a provision for a legal claim based on incremental costs only. Under the proposals, the company would need to include all direct costs, such as the internal legal team payroll and an allocation of other costs.
Which discount rate do you use when discounting a long-term provision?
In applying IAS 37, the approach to determining the discount rate for long-term provisions varies between companies – i.e. some use a risk-free rate; others adjust the rate for non-performance or their own credit risk.
The IASB proposes to use a risk-free discount rate in measuring a long-term provision. Depending on the company’s current accounting policy, some provisions may become larger.
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