Provisions, Contingent Liabilities and Contingent Assets
The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingent liabilities and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.
The objective of this Standard is also to lay down appropriate accounting for contingent assets.
1. This Standard should be applied in accounting for provisions and contingent liabilities and in dealing with contingent assets, except:
(a) those resulting from financial instruments fair value; that are carried at
(b) those resulting from executory contracts, except where the contract is onerous;
An ‘onerous contract’ is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
Thus, for a contract to qualify as an onerous contract, the unavoidable costs of meeting the obligation under the contract should exceed the economic benefits expected to be received under it.
The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it.
If an enterprise has a contract that is onerous, the present obligation under the contract is recognised and measured as a provision as per this Standard.
(c) those arising in insurance enterprises from contracts with policy-holders; and
(d) those covered by another Accounting Standard.
2. This Standard applies to financial instruments (including guarantees) that are not carried at fair value.
3. Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent.
This Standard does not apply to executory contracts unless they are onerous.
4. This Standard applies to provisions, contingent liabilities and contingent assets of insurance enterprises other than those arising from contracts with policy-holders.
5. Where another Accounting Standard deals with a specific type of provision, contingent liability or contingent asset, an enterprise applies that Standard instead of this Standard.
For example, certain types of provisions are also addressed in Accounting Standards on:
(a) construction contracts (see AS 7, Construction Contracts);
(b) taxes on income (see AS 22, Accounting for Taxes on Income);
(c) leases (see AS 19, Leases). However, as AS 19 contains no specific requirements to deal with operating leases that have become onerous, this Standard applies to such cases; and
(d) retirement benefits (see AS 15, Accounting for Retirement Benefits in the Financial Statements of Employers).
6. Some amounts treated as provisions may relate to the recognition of revenue, for example where an enterprise gives guarantees in exchange for a fee.
This Standard does not address the recognition of revenue. AS 9, Revenue Recognition, identifies the circumstances in which revenue is recognised and provides practical guidance on the application of the recognition criteria.
This Standard does not change the requirements of AS 9.
7. This Standard defines provisions as liabilities which can be measured only by using a substantial degree of estimation.
The term ‘provision’ is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Standard.
8. Other Accounting Standards specify whether expenditures are treated as assets or as expenses.
These issues are not addressed in this Standard.
Accordingly, this Standard neither prohibits nor requires capitalisation of the costs recognised when a provision is made.
9. This Standard applies to provisions for restructuring (including discontinuing operations).
Where a restructuring meets the definition of a discontinuing operation, additional disclosures are required by AS 24, Discontinuing Operations.
10. The following terms are used in this Standard with the meanings specified:
10.1 A provision is a liability which can be measured only by using a substantial degree of estimation.
10.2 A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
10.3 An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.
10.4 A contingent liability is:
(a) a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.
10.5 A contingent asset is a possible asset that arises from past events the existence of which will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the enterprise.
10.6 Present obligation – an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not.
10.7 Possible obligation – an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable.
10.8 A restructuring is a programme that is planned and controlled by management, and materially changes either:
(a) the scope of a business undertaken by an enterprise; or
(b) the manner in which that business is conducted.
11. An obligation is a duty or responsibility to act or perform in a certain way.
Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement.
Obligations also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.
12. Provisions can be distinguished from other liabilities such as trade payables and accruals because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement.
(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and
(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees.
Although it is sometimes necessary to estimate the amount of accruals, the degree of estimation is generally much less than that for provisions.
13. In this Standard, the term ‘contingent’ is used for liabilities and assets that are not recognised because their existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise.
In addition, the term ‘contingent liability’ is used for liabilities that do not meet the recognition criteria.
14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognised.
15. In almost all cases it will be clear whether a past event has given rise to a present obligation.
In rare cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation.
In such a case, an enterprise determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, including, for example, the opinion of experts.
The evidence considered includes any additional evidence provided by events after the balance sheet date. On the basis of such evidence:
(a) where it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognises a provision (if the recognition criteria are met); and
(b) where 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).
16. A past event that leads to a present obligation is called an obligating event.
For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.
17. Financial statements deal with the financial position of an enterprise at the end of its reporting period and not its possible position in the future.
Therefore, no provision is recognised for costs that need to be incurred to operate in the future.
The only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date.
18. It is only those obligations arising from past events existing independently of an enterprise’s future actions (i.e. the future conduct of its business) that are recognised as provisions.
Examples of such obligations are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the enterprise.
Similarly, an enterprise recognises a provision for the decommissioning costs of an oil installation to the extent that the enterprise is obliged to rectify damage already caused.
In contrast, because of commercial pressures or legal requirements, an enterprise may intend or need to carry out expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory).
Because the enterprise can avoid the future expenditure by its future actions, for example by changing its method of operation, it has no present obligation for that future expenditure and no provision is recognised.
19. An obligation always involves another party to whom the obligation is owed.
It is not necessary, however, to know the identity of the party to whom the obligation is owed – indeed the obligation may be to the public at large.
20. An event that does not give rise to an obligation immediately may do so at a later date, because of changes in the law.
For example, when environmental damage is caused there may be no obligation to remedy the consequences.
However, the causing of the damage will become an obligating event when a new law requires the existing damage to be rectified.
21. Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is virtually certain to be enacted.
Differences in circumstances surrounding enactment usually make it impossible to specify a single event that would make the enactment of a law virtually certain.
In many cases it will be impossible to be virtually certain of the enactment of a law until it is enacted.
Probable Outflow of Resources Embodying Economic Benefits
22. For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation.
For the purpose of this Standard , an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not.
Where 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).
23. Where there are a number of similar obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement is determined by considering the class of obligations as a whole.
Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole.
If that is the case, a provision is recognised (if the other recognition criteria are met).
Reliable Estimate of the Obligation
24. The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability.
This is especially true in the case of provisions, which by their nature involve a greater degree of estimation than most other items.
Except in extremely rare cases, an enterprise will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is reliable to use in recognising a provision.
25. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability (see paragraph 68).
26. An enterprise should not recognise a contingent liability.
27. A contingent liability is disclosed, as required by paragraph 68, unless the possibility of an outflow of resources embodying economic benefits is remote.
28. Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability.
The enterprise recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made (see paragraph 14).
29. Contingent liabilities may develop in a way not initially expected.
Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable.
If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in accordance with paragraph 14 in the financial statements of the period in which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be made).
30. An enterprise should not recognise a contingent asset.
31. Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the enterprise.
An example is a claim that an enterprise is pursuing through legal processes, where the outcome is uncertain.
32. Contingent assets are not recognised in financial statements since this may result in the recognition of income that may never be realised.
However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.
33. A contingent asset is not disclosed in the financial statements.
It is usually disclosed in the report of the approving authority (Board of Directors in the case of a company, and, the corresponding approving authority in the case of any other enterprise), where an inflow of economic benefits is probable.
34. Contingent assets are assessed continually and if it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognised in the financial statements of the period in which the change occurs.
35. The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date.
The amount of a provision should not be discounted to its present value except in case of decommissioning, restoration and similar liabilities that are recognised as cost of Property, Plant and Equipment.
The discount rate (or rates) should be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability.
The discount rate(s) should not reflect risks for which future cash flow estimates have been adjusted.
Periodic unwinding of discount should be recognised in the statement of profit and loss.
36. The estimates of outcome and financial effect are determined by the judgment of the management of the enterprise, supplemented by experience of similar transactions and, in some cases, reports from independent experts.
The evidence considered includes any additional evidence provided by events after the balance sheet date.
37. The provision is measured before tax; the tax consequences of the provision, and changes in it, are dealt with under AS 22, Accounting for Taxes on Income.
Risks and Uncertainties
38. The risks and uncertainties that inevitably surround many events and circumstances should be taken into account in reaching the best estimate of a provision.
39. Risk describes variability of outcome.
A risk adjustment may increase the amount at which a liability is measured.
Caution is needed in making judgments under conditions of uncertainty, so that income or assets are not overstated and expenses or liabilities are not understated.
However, uncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities.
For example, if the projected costs of a particularly adverse outcome are estimated on a prudent basis, that outcome is not then deliberately treated as more probable than is realistically the case.
Care is needed to avoid duplicating adjustments for risk and uncertainty with consequent overstatement of a provision.
40. Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph 67(b).
41. Future events that may affect the amount required to settle an obligation should be reflected in the amount of a provision where there is sufficient objective evidence that they will occur.
42. Expected future events may be particularly important in measuring provisions.
For example, an enterprise may believe that the cost of cleaning up a site at the end of its life will be reduced by future changes in technology.
The amount recognised reflects a reasonable expectation of technically qualified, objective observers, taking account of all available evidence as to the technology that will be available at the time of the clean-up.
Thus, it is appropriate to include, for example, expected cost reductions associated with increased experience in applying existing technology or the expected cost of applying existing technology to a larger or more complex clean-up operation than has previously been carried out.
However, an enterprise does not anticipate the development of a completely new technology for cleaning up unless it is supported by sufficient objective evidence.
43. The effect of possible new legislation is taken into consideration in measuring an existing obligation when sufficient objective evidence exists that the legislation is virtually certain to be enacted.
The variety of circumstances that arise in practice usually makes it impossible to specify a single event that will provide sufficient, objective evidence in every case.
Evidence is required both of what legislation will demand and of whether it is virtually certain to be enacted and implemented in due course.
In many cases sufficient objective evidence will not exist until the new legislation is enacted.
Expected Disposal of Assets
44. Gains from the expected disposal of assets should not be taken into account in measuring a provision.
45. Gains on the expected disposal of assets are not taken into account in measuring a provision, even if the expected disposal is closely linked to the event giving rise to the provision. Instead, an enterprise recognises gains on expected disposals of assets at the time specified by the Accounting Standard dealing with the assets concerned.
46. Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation.
The reimbursement should be treated as a separate asset. The amount recognised for the reimbursement should not exceed the amount of the provision.
47. In the statement of profit and loss, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.
48. Sometimes, an enterprise is able to look to another party to pay part or all of the expenditure required to settle a provision (for example, through insurance contracts, indemnity clauses or suppliers’ warranties).
The other party may either reimburse amounts paid by the enterprise or pay the amounts directly.
49. In most cases, the enterprise will remain liable for the whole of the amount in question so that the enterprise would have to settle the full amount if the third party failed to pay for any reason.
In this situation, a provision is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is recognised when it is virtually certain that reimbursement will be received if the enterprise settles the liability.
50. In some cases, the enterprise will not be liable for the costs in question if the third party fails to pay. In such a case, the enterprise has no liability for those costs and they are not included in the provision.
51. As noted in paragraph 28, an obligation for which an enterprise is jointly and severally liable is a contingent liability to the extent that it is expected that the obligation will be settled by the other parties.
Changes in Provisions
52. Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed.
Use of Provisions
53. A provision should be used only for expenditures for which the provision was originally recognised.
54. Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.
Application of the Recognition and Measurement Rules
Future Operating Losses
55. Provisions should not be recognised for future operating losses.
56. Future operating losses do not meet the definition of a liability in paragraph 10 and the general recognition criteria set out for provisions in paragraph 14.
57. An expectation of future operating losses is an indication that certain assets of the operation may be impaired. An enterprise tests these assets for impairment under Accounting Standard (AS) 28, Impairment of Assets.
58. The following are examples of events that may fall under the definition of restructuring:
(a) sale or termination of a line of business;
(b) the closure of business locations in a country or region or the relocation of business activities from one country or region to another;
(c) changes in management structure, for example, eliminating a layer of management; and
(d) fundamental re-organisations that have a material effect on the nature and focus of the enterprise’s operations.
59. A provision for restructuring costs is recognised only when the recognition criteria for provisions set out in paragraph 14 are met.
60. No obligation arises for the sale of an operation until the enterprise is committed to the sale, i.e., there is a binding sale agreement.
61. An enterprise cannot be committed to the sale until a purchaser has been identified and there is a binding sale agreement.
Until there is a binding sale agreement, the enterprise will be able to change its mind and indeed will have to take another course of action if a purchaser cannot be found on acceptable terms.
When the sale of an operation is envisaged as part of a restructuring, the assets of the operation are reviewed for impairment under Accounting Standard (AS) 28, Impairment of Assets.
62. A restructuring provision should include only the direct expenditures arising from the restructuring which are those that are both:
(a) necessarily entailed by the restructuring; and
(b) not associated with the ongoing activities of the enterprise.
63. A restructuring provision does not include such costs as:
(a) retraining or relocating continuing staff;
(b) marketing; or
(c) investment in new systems and distribution networks.
These expenditures relate to the future conduct of the business and are not liabilities for restructuring at the balance sheet date.
Such expenditures are recognised on the same basis as if they arose independently of a restructuring.
64. Identifiable future operating losses up to the date of a restructuring are not included in a provision.
65. As required by paragraph 44, gains on the expected disposal of assets are not taken into account in measuring a restructuring provision, even if the sale of assets is envisaged as part of the restructuring.
66. For each class of provision, an enterprise should disclose:
(a) the carrying amount at the beginning and end of the period;
(b) additional provisions made in the period, including increases to existing provisions;
(c) amounts used (i.e. incurred and charged against the provision) during the period; and
(d) unused amounts reversed during the period.
67. An enterprise should disclose the following for each class of provision:
(a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits;
(b) an indication of the uncertainties about those outflows. Where necessary to provide adequate information, an enterprise should disclose the major assumptions made concerning future events, as addressed in paragraph 41; and
(c) the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.
68. Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable:
(a) an estimate of its financial effect, measured under paragraphs 35- 45;
(b) an indication of the uncertainties relating to any outflow; and
(c) the possibility of any reimbursement.
69. In determining which provisions or contingent liabilities may be aggregated to form a class, it is necessary to consider whether the nature of the items is sufficiently similar for a single statement about them to fulfill the requirements of paragraphs 67 (a) and (b) and 68 (a) and (b).
Thus, it may be appropriate to treat as a single class of provision amounts relating to warranties of different products, but it would not be appropriate to treat as a single class amounts relating to normal warranties and amounts that are subject to legal proceedings.
70. Where a provision and a contingent liability arise from the same set of circumstances, an enterprise makes the disclosures required by paragraphs 66-68 in a way that shows the link between the provision and the contingent liability.
71. Where any of the information required by paragraph 68 is not disclosed because it is not practicable to do so, that fact should be stated.
72. In extremely rare cases, disclosure of some or all of the information required by paragraphs 66-70 can be expected to prejudice seriously the position of the enterprise in a dispute with other parties on the subject matter of the provision or contingent liability.
In such cases, an enterprise need not disclose the information, but should disclose the general nature of the dispute, together with the fact that, and reason why, the information has not been disclosed.
73. All the existing provisions for decommissioning, restoration and similar liabilities (see paragraph 35) should be discounted prospectively, with the corresponding effect to the related item of property, plant and equipment.