AS 29 – Provisions, Contingent Liabilities and Contingent Assets | Advanced Accounting for CA Intermediate PDF Download

Provisions, Contingent Liabilities and Contingent Assets

Objective

• The main aim of this standard is to ensure that provisions and contingent liabilities are recognized and measured appropriately. It also emphasizes the disclosure of sufficient information in financial statements for users to grasp their nature, timing, and amount. Additionally, the standard outlines the correct accounting treatment for contingent assets.
• For instance, let's consider a company that is facing a lawsuit. The company needs to set aside a provision for the potential loss from the lawsuit based on the best estimate available. This provision is crucial for accurately reflecting the company's financial position.
• Furthermore, contingent assets like potential future economic benefits resulting from past events need to be considered. These assets are disclosed in financial statements only when their realization becomes virtually certain.
• The standard was updated in 2016 to align with evolving accounting practices and ensure transparency in financial reporting.
• It's important to note that accounting standards, including this one, apply primarily to material items, emphasizing the significance of accurately reflecting key financial elements.

Scope

• This standard guides the accounting treatment for provisions, contingent liabilities, and contingent assets, excluding certain cases like those related to financial instruments carried at fair value or arising from executory contracts unless they are onerous.
• Provisions are recognized when unavoidable costs outweigh expected benefits in a contract, with recognition and measurement done as per the standard. An example of an onerous contract is one where the costs of fulfilling obligations exceed the benefits received.
• Insurance enterprises are exempt from applying this standard to provisions arising from contracts with policy-holders or those covered by another accounting standard.
• Financial instruments not carried at fair value fall under the purview of this standard, while executory contracts are included only if deemed onerous.
• Specific types of provisions, contingent liabilities, or assets covered by other accounting standards should follow those standards instead of this one. For instance, operating leases falling under onerous conditions are addressed by this standard.
• Provisions, contingent liabilities, and assets in insurance enterprises are covered by this standard, excluding those arising from policy-holder contracts.
• The standard does not address revenue recognition related to provisions. Revenue recognition specifics are outlined in AS 9, Revenue Recognition.
• Provisions are defined as liabilities requiring substantial estimation. The term 'provision' also extends to adjustments like depreciation, asset impairments, and doubtful debts, not tackled in this standard.
• Decisions on treating expenditures as assets or expenses are stipulated by other accounting standards, not within the scope of this standard. Capitalization of costs during provision is neither mandated nor prohibited.
• Restructuring provisions, including those for discontinuing operations, are encompassed by this standard. Discontinuing operations meeting specific criteria necessitate additional disclosures as per AS 24, Discontinuing Operations.

Definitions

• A provision is a liability that requires estimation for measurement.
• A liability is an obligation from past events, expecting an outflow of resources for settlement.
• An obligating event creates an obligation with no realistic alternative for settlement.
• A contingent liability is a possible obligation from past events, confirmed by uncertain future events.
• A contingent asset is a potential asset arising from past events, confirmed by uncertain future events.
• Present obligation is probable at the balance sheet date.
• Possible obligation is considered not probable at the balance sheet date.
• A restructuring is a planned program by management, materially changing business scope or conduct.

Obligations and Provisions

• An obligation is a duty to act in a specific way, stemming from contracts, statutes, or business practices.
• Provisions differ from trade payables and accruals by involving significant estimation for future settlement expenses.

Contingent Liabilities and Assets

• ‘Contingent’ denotes unconfirmed liabilities and assets, dependent on uncertain future events.
• ‘Contingent liability’ refers to unrecognised liabilities failing to meet recognition criteria.

Recognition

Provisions

A provision should be recognized when:

• an enterprise has a present obligation due to a past event;
• it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
• a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision should be recognized.

Present Obligation

In most cases, it will be clear if a past event has given rise to a present obligation. In rare cases, such as lawsuits, there may be disputes about whether certain events occurred or if those events result in a present obligation. In such cases, an enterprise determines the existence of a present obligation at the balance sheet date by considering all available evidence, including expert opinions and additional evidence provided by events after the balance sheet date. Based on this evidence:

• if it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognizes a provision (if the recognition criteria are met); and
• if it is more likely that no present obligation exists at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).

Past Event

• A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, the enterprise must have no realistic alternative to settling the obligation created by the event.
• Financial statements reflect the financial position of an enterprise at the end of its reporting period, not its possible future position. Therefore, no provision is recognized for future operating costs. The only liabilities recognized in an enterprise’s balance sheet are those existing at the balance sheet date.
• Only obligations arising from past events that exist independently of the enterprise’s future actions (i.e., future business conduct) are recognized as provisions. Examples include penalties or clean-up costs for unlawful environmental damage, which lead to an outflow of resources embodying economic benefits in settlement regardless of the enterprise's future actions. Similarly, an enterprise recognizes a provision for the decommissioning costs of an oil installation to the extent that it is obliged to rectify damage already caused. In contrast, due to commercial pressures or legal requirements, an enterprise may intend or need to incur expenditure to operate in a particular way in the future (e.g., fitting smoke filters in a factory). Since the enterprise can avoid this future expenditure by changing its operations, it has no present obligation for that future expenditure and no provision is recognized.
• An obligation always involves another party to whom the obligation is owed. It is not necessary to know the party's identity; the obligation may be owed to the public at large.
• An event that does not immediately give rise to an obligation may do so later due to legal changes. For example, environmental damage may not initially create an obligation to remedy the consequences. However, the damage becomes an obligating event when a new law requires the existing damage to be rectified.
• When details of a proposed new law are not finalized, an obligation arises only when the legislation is virtually certain to be enacted. Differences in enactment circumstances often make it impossible to pinpoint a single event that makes the enactment of a law virtually certain. In many cases, it is impossible to be virtually certain of the enactment of a law until it is enacted.

Probable Outflow of Resources Embodying Economic Benefits

• For a liability to be recognized, there must be a present obligation and a probable outflow of resources embodying economic benefits to settle that obligation. For the purposes of this standard, an outflow of resources or another event is considered probable if it is more likely than not to occur, i.e., the probability of the event occurring is greater than the probability of it not occurring. When it is not probable that a present obligation exists, an enterprise discloses a contingent liability unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).
• For a group of similar obligations (e.g., product warranties or similar contracts), the probability of an outflow is assessed by considering the entire class of obligations. Even if the likelihood of an outflow for any single item is small, it may be probable that some outflow will be needed to settle the class of obligations as a whole. If this is the case, a provision is recognized (if the other recognition criteria are met).

Reliable Estimate of the Obligation

• Estimation is essential in preparing financial statements and does not undermine their reliability. This is especially true for provisions, which typically involve more estimation than other items. Except in extremely rare cases, an enterprise can determine a range of possible outcomes and thus make a reliable estimate of the obligation for recognizing a provision.
• In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognized. This liability is disclosed as a contingent liability (see paragraph 68).

Contingent Liabilities

• An enterprise does not record a contingent liability in its financial statements.
• However, it discloses this liability unless the likelihood of an outflow of resources with benefits is remote.
• When an enterprise shares an obligation with others, the part anticipated to be covered by them is considered contingent.
• The enterprise only recognizes a provision for the portion where an outflow of resources bringing economic benefits is likely, except in rare cases where no reliable estimate is feasible.
• Contingent liabilities are subject to continuous assessment as they may evolve unexpectedly.
• If the probability of an outflow of future economic benefits becomes likely for a previously treated contingent liability, a provision is acknowledged in the financial statements.

Contingent Assets

• An enterprise should not recognize a contingent asset.
• Contingent assets typically stem from unforeseen events that could lead to potential economic benefits for the enterprise. For instance, this could involve a claim being pursued through legal channels where the outcome remains uncertain.
• Contingent assets are not reflected in financial statements as doing so might result in the recognition of income that may never materialize. However, if the realization of income is highly probable, then the associated asset is not considered contingent and can be recognized appropriately.
• A contingent asset is not disclosed in financial statements but may be mentioned in the report of the governing body (such as the Board of Directors in the case of a company) when there is a high likelihood of economic benefits flowing in.
• Contingent assets are continuously evaluated, and if it becomes almost certain that economic benefits will be received, both the asset and related income are recorded in the financial statements for the period in which the change occurs.

Measurement

Best Estimate

• The provision amount recognized should represent the best estimate of the expenditure needed to settle the current obligation by the balance sheet date. It's important to note that this provision amount should generally not be discounted to present value, except in specific cases like decommissioning or restoration liabilities related to Property, Plant, and Equipment costs.
• The discount rate used should be a pre-tax rate reflecting current market perceptions of the time value of money and liability-specific risks. It shouldn't account for risks where future cash flow estimates have been adjusted. Any periodic unwinding of the discount should be accounted for in the profit and loss statement.
• Estimates regarding outcomes and financial impacts are primarily based on management's judgment, along with past experiences from similar transactions and sometimes insights from independent experts. Additional evidence post the balance sheet date is also taken into consideration.
• The provision is measured pre-tax; any tax implications of the provision and subsequent changes are addressed under AS 22, which deals with Accounting for Taxes on Income.

Risks and Uncertainties

• Risks and Uncertainties: In estimating a provision, it's crucial to consider the risks and uncertainties associated with various events and circumstances. Risk pertains to the variability of outcomes. Adjustments for risk may lead to an increase in the measured liability to ensure that income or assets are not overstated and expenses or liabilities are not understated. It's essential to exercise caution in judgment under conditions of uncertainty to prevent the creation of excessive provisions or deliberate overstatement of liabilities. For instance, if projected costs are estimated prudently for an adverse outcome, it should not be treated as more probable than it realistically is. Care must be taken to avoid duplicating adjustments for risk and uncertainty, which could result in an overstatement of a provision.
• Disclosure of Uncertainties: Information about uncertainties surrounding expenditure amounts should be disclosed as per paragraph 67(b).

Future Events

• Impact of Future Events: Future events that may influence the amount needed to settle an obligation should be considered in determining a provision, provided there is sufficient objective evidence indicating their occurrence.
• Significance of Expected Future Events: Anticipated future events play a significant role in provision measurement. For instance, an organization might expect cost reductions in site cleanup due to technological advancements. The recognized amount should reflect a reasonable expectation based on objective observations by qualified experts, considering available evidence on future technology. Expected cost reductions due to increased experience or applying existing technology to larger or more complex operations can be included. However, projecting the development of entirely new technology for cleanup requires substantial objective evidence.
• Consideration of New Legislation: Possible impacts of new legislation should be factored into measuring existing obligations if there is substantial evidence that the legislation will be enacted. Determining the certainty of new legislation involves assessing both what the law will require and whether it's virtually certain to be implemented. In many cases, concrete evidence may not emerge until the legislation is officially enacted.

Expected Disposal of Assets

• Gains from the planned disposal of assets should not be factored into the assessment of a provision.
• Gains derived from the anticipated disposal of assets are not considered when calculating a provision, even if the disposal is closely related to the event leading to the provision. Instead, any gains from expected asset disposals are recognized in accordance with the relevant Accounting Standard for the specific assets involved.

Reimbursements

• If some or all of the expenses needed to settle a provision are anticipated to be reimbursed by another party, the reimbursement should only be recognized when it is almost certain that the reimbursement will be received upon settlement of the obligation. This reimbursement is treated as a distinct asset and should not exceed the provision amount.
• In the financial statements, the provision-related expenses may be shown net of any recognized reimbursement amount.
• There are situations where an enterprise can seek payment from another party to cover part or all of the expenses required to settle a provision (e.g., through insurance agreements, indemnity clauses, or suppliers' warranties).
• Provisions need to be reassessed at each balance sheet date and adjusted to reflect the current best estimate. If it becomes unlikely that an outflow of resources will be needed to settle the obligation, the provision should be reversed.

Application of the Recognition and Measurement Rules

Disclosure

For each category of provision, a company must reveal:

• The initial and final amounts during the period.
• Any new provisions established, including augmentations to existing ones.
• The sums utilized during the period (i.e., expenses incurred and charged against the provision).
• Any unused amounts reversed during the period.

A company should disclose the following for each provision category:

• A concise explanation of the obligation's nature and the expected timing of any resulting economic outflows.
• Information about uncertainties related to these outflows. If necessary, major assumptions regarding future events should be disclosed.
• The anticipated reimbursement amount, indicating any recognized asset for the reimbursement.

Unless the likelihood of an outflow is remote, a company must disclose for each contingent liability at the balance sheet date:

• A brief description of the contingent liability's nature.
• If feasible, an estimate of its financial impact as per specific measurements.
• Details about uncertainties concerning any outflow and the potential for reimbursement.
• When deciding which provisions or contingent liabilities can be grouped together, similarity in nature is crucial for cohesive reporting.
• If a provision and a contingent liability stem from the same context, disclosures should highlight the connection between them.
• If certain information as required by guidelines cannot be disclosed due to impracticability, this should be explicitly stated.
• In rare cases where divulging information might significantly harm the company's position in a dispute, the details can be withheld, but a general overview of the disagreement must be provided along with reasons for non-disclosure.