IFRS requirements for provisions and contingent … WEBCAST Oct 29...1 IFRS requirements for provisions and contingent liabilities October 29, 2013 Administrative CPE regulations require
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IFRS requirements qfor provisions and contingent liabilities
October 29, 2013
Administrative
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On February 5, 2013, an employee filed a $2,000,000 lawsuit against MFC for damages suffered when one of MFC’s factory-making factories exploded on December 29, 2012.
MFC’s lawyers expect the company will lose the lawsuit and estimate the loss to be between $500,000 and $1,000,000, with no one outcome being assessed as more likely than any other.
The employee has offered to settle the lawsuit out of court for $900,000, but MFC plans to litigate.
What amount should MFC report as a liability from the lawsuit under U.S. GAAP in its December 31, 2012 statement of financial position?
1. Incorrect, MFC would recognize $500,000 because that’s the lower end of the range of possible outcomes with no other outcome more likely than any other.
2. Incorrect, MFC would recognize $500,000 because that’s the lower end of the range of possible outcomes with no other outcome more likely than any other.
3. Correct, MFC would recognize $500,000 because that’s the lower end of the range of possible outcomes with no other outcome more likely than any other.
4. Incorrect, MFC would recognize $500,000 because that’s the lower end of the range of possible outcomes with no other outcome more likely than any other.
U.S. GAAP difference or potential difference with U.S. GAAP
Question 2
On February 5, 2013, an employee filed a $2,000,000 lawsuit against MFC for damages suffered when one of MFC’s factory-making factories exploded on December 29, 2012.
MFC’s lawyers expect the company will lose the lawsuit and estimate the loss to be between $500,000 and $1,000,000, with no one outcome being assessed as more likely than any other.
The employee has offered to settle the lawsuit out of court for $900,000, but MFC plans to litigate.
What amount should MFC report as a liability from the lawsuit under IFRS in its December 31, 2012 statement of financial position?
The amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation, if material (IAS 37.45)
The discount rate shall be a pretax rate that reflects current market assessments of the time value of money and the risks specific to the liability but shall not reflect risks for which future cash flow estimates have been adjusted (IAS 37.47)
Often complex and involves high degree of judgment!
Question 3
Which discount rate should be used to determine the present value of a provision under IFRS in accordance with IAS 37?
1. The discount rate shall be a posttax rate and include reasonable estimates.
2 The discount rate shall be a pretax rate and the use of the incremental borrowing rate of the2. The discount rate shall be a pretax rate and the use of the incremental borrowing rate of the reporting entity would be the best reference point for its determination.
3. The discount rate shall the reporting entity’s weighted average cost of capital (WACC).
4. The discount rate shall be a pretax rate that reflects current market assessments of the time value of money and the risks specific to the liability, but shall not reflect risks for which future cash flow estimates have been adjusted.
1. Incorrect, the discount rate shall be a pretax rate.
2. Incorrect, the incremental borrowing rate is not the best reference point for the determination of the discount rate.
3 Incorrect the WACC does not reflect the risks specific to the provision3. Incorrect, the WACC does not reflect the risks specific to the provision.
4. Correct, The discount rate shall be a pretax rate that reflects current market assessments of the time value of money and the risks specific to the liability but shall not reflect risks for which future cash flow estimates have been adjusted.
Definition: Contract in which the unavoidable costs of meeting the obligation exceed the economic benefits expected to be received under it.
The present obligation under the contract should be recognized as a provision.
Measurement at the lower of the fulfillment cost and any compensation or penalties arising Measurement at the lower of the fulfillment cost and any compensation or penalties arising from failure to fulfill it.
First consider additional impairment losses on assets dedicated to the onerous contract.
The assessment should be based on the contract as a whole rather than on an item-by-item basis.
1. The accounting for onerous contracts is the same between IFRS and U.S. GAAP.
2. U.S. GAAP has no accounting guidance related to onerous contracts.
3. IFRS provides for an accounting policy choice to account for onerous contracts if management believes recognizing a provision would be useful information to users of the financial statements.
4. Under IFRS, if an entity has a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision.
1. Incorrect, the accounting for onerous contracts is different between IFRS and U.S. GAAP.
2. Incorrect, there is guidance under U.S. GAAP dealing with onerous/loss making contracts.
3. Incorrect, the accounting for onerous contracts is not an accounting policy choice under IFRSunder IFRS.
4. Correct, under IFRS, if an entity has a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision.
A constructive obligation for a restructuring arises only when:
A restructuring is a program planned and controlled by management that materially changes the scope of the business or the manner in which it is conducted.
1. There is a formal plan for the restructuring.
2. The entity has raised a valid expectation in those affected that it will carry out the plan.
1. Incorrect, differences in the accounting are generally expected.
2. Incorrect, IAS 37 outlines the requirements for the accounting for provisions.
3. Incorrect, generally, U.S. GAAP does not require recognizing the present value.
4. Correct, in applying the recognition and measurement requirements under IFRS it is possible that there could be significant differences with U.S. GAAP.
Uncertainty regarding timing results in recognition with the uncertainty considered in the best estimate
Asset retirement obligation
Uncertainty might result in conclusion that is not recognized.
Di t th t d h fl imeasurement.
Pretax rate reflecting time value of money and the risk specific to the liability. Discount rate does not include an adjustment for an entity’s own credit risk.
Effect of any change to an existing obligation is added or deducted from the cost of the related asset and depreciated
Discount the expected cash flows using an interest rate that equates a risk-free interest rate adjusted for the effect of the entity’s credit standing (credit-adjusted, risk-free rate).
Unlike IFRS, if the estimated amount of cash flows changes, then the original discount rate is used for decreases, but a current rate is used for increases
prospectively. Changes in provisions include change in discount rate.
(layering approach).
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Summary
The main factor to define a provision is if a present obligations exists from the result of a pastevent.
Four Major Factors for Recognition Legal Constructive Virtually Certain and Recognize Four Major Factors for Recognition – Legal, Constructive, Virtually Certain, and Recognize
Best Estimate Considerations – Should be taken into account when looking at the reliability of measurement, the outcome could be the amount an entity must pay on the balance sheet date.
Onerous Contracts – Only avoidable costs that are associated with meeting the entity’s obligations should be considered.
Restructuring – A constructive obligation can only occur when there is a plan for formal restructuring and there is a valid expectation to carry out the plan.
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