Question

Assume that Exxon accounts for contingencies using IAS 37. Prepare 3 paragraphs (4 sentences or less for each paragraph/question) addressing the following: Explain why you agree or don’t agree that IAS 37 provides sufficient guidance to provide users enough disclosure about environmental liabilities.

Answer 1

I agree with the IAS 37 because it ensures that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount.

The key principle established by the Standard is that a provision should be recognised only when there is a liability i.e. a present obligation resulting from past events. The Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements – planned future expenditure, even where authorised by the board of directors or equivalent governing body, is excluded from recognition.

Since there is common ground as regards liabilities that are uncertain, IAS 37 also deals with contingencies. It requires that entities should not recognise contingent liabilities – but should disclose them, unless the possibility of an outflow of economic resources is remote

Contingent assets should not be recognised – but should be disclosed where an inflow of economic benefits is probable. When the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.

IAS 37 excludes obligations and contingencies arising from:

• financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition and Measurement (or IFRS 9 Financial Instruments)
• non-onerous executory contracts
• insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other provisions, contingent liabilities and contingent assets of an insurer
• items covered by another IFRS. For example, IAS 11 Construction Contracts applies to obligations arising under such contracts; IAS 12 Income Taxes applies to obligations for current or deferred income taxes; IAS 17 Leases applies to lease obligations; and IAS 19 Employee Benefits applies to pension and other employee benefit obligations.

Provision: a liability of uncertain timing or amount.

Liability:

• present obligation as a result of past events
• settlement is expected to result in an outflow of resources (payment)

Contingent liability:

• a possible obligation depending on whether some uncertain future event occurs, or
• a present obligation but payment is not probable or the amount cannot be measured reliably

Contingent asset:

• a possible asset that arises from past events, and
• whose 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 entity.

Recognition of a provision

An entity must recognise a provision if, and only if: [IAS 37.14]

• a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event),
• payment is probable ('more likely than not'), and
• the amount can be estimated reliably.

Measurement of provisions

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, that is, the amount that an entity would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party. This means:

• Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount.
• Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value.
• Both measurements are at discounted present value using a pre-tax discount rate that reflects the current market assessments of the time value of money and the risks specific to the liability.

In reaching its best estimate, the entity should take into account the risks and uncertainties that surround the underlying events.

If some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised as a separate asset, and not as a reduction of the required provision, when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The amount recognised should not exceed the amount of the provision.

In measuring a provision consider future events as follows:

• forecast reasonable changes in applying existing technology
• ignore possible gains on sale of assets
• consider changes in legislation only if virtually certain to be enacted

Remeasurement of provisions

• Review and adjust provisions at each balance sheet date
• If an outflow no longer probable, provision is reversed