All the entities in the examples have 31 December year‑ends. In all cases, it is assumed that a reliable estimate can be made of any outflows expected. In some examples the circumstances described may have resulted in impairment of the assets—this aspect is not dealt with in the examples.
The cross‑references provided in the examples indicate paragraphs of the Standard that are particularly relevant.
References to ‘best estimate’ [Refer:paragraphs 36–44] are to the present value [Refer:paragraphs 45–47] amount, where the effect of the time value of money is material.
A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale. On past experience, it is probable (ie more likely than not) that there will be some claims under the warranties.
Present obligation as a result of a past obligating event – The obligating event is the sale of the product with a warranty, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits in settlement – Probable for the warranties as a whole (see paragraph 24).
Conclusion – A provision is recognised for the best estimate of the costs of making good under the warranty products sold before the end of the reporting period (see paragraphs 14 and 24).
An entity in the oil industry causes contamination but cleans up only when required to do so under the laws of the particular country in which it operates. One country in which it operates has had no legislation requiring cleaning up, and the entity has been contaminating land in that country for several years. At 31 December 20X0 it is virtually certain that a draft law requiring a clean‑up of land already contaminated will be enacted shortly after the year‑end.
Present obligation as a result of a past obligating event – The obligating event is the contamination of the land because of the virtual certainty of legislation requiring cleaning up.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognised for the best estimate of the costs of the clean‑up (see paragraphs 14 and 22).
An entity in the oil industry causes contamination and operates in a country where there is no environmental legislation. However, the entity has a widely published environmental policy in which it undertakes to clean up all contamination that it causes. The entity has a record of honouring this published policy.
Present obligation as a result of a past obligating event – The obligating event is the contamination of the land, which gives rise to a constructive obligation because the conduct of the entity has created a valid expectation on the part of those affected by it that the entity will clean up contamination.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognised for the best estimate of the costs of clean‑up (see paragraphs 10 (the definition of a constructive obligation), 14 and 17).
An entity operates an offshore oilfield where its licensing agreement requires it to remove the oil rig at the end of production and restore the seabed. Ninety per cent of the eventual costs relate to the removal of the oil rig and restoration of damage caused by building it, and 10 per cent arise through the extraction of oil. At the end of the reporting period, the rig has been constructed but no oil has been extracted.
Present obligation as a result of a past obligating event – The construction of the oil rig creates a legal obligation under the terms of the licence to remove the rig and restore the seabed and is thus an obligating event. At the end of the reporting period, however, there is no obligation to rectify the damage that will be caused by extraction of the oil.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognised for the best estimate of ninety per cent of the eventual costs that relate to the removal of the oil rig and restoration of damage caused by building it (see paragraph 14). These costs are included as part of the cost of the oil rig. The 10 per cent of costs that arise through the extraction of oil are recognised as a liability when the oil is extracted.
A retail store has a policy of refunding purchases by dissatisfied customers, even though it is under no legal obligation to do so. Its policy of making refunds is generally known.
Present obligation as a result of a past obligating event – The obligating event is the sale of the product, which gives rise to a constructive obligation because the conduct of the store has created a valid expectation on the part of its customers that the store will refund purchases.
An outflow of resources embodying economic benefits in settlement – Probable, a proportion of goods are returned for refund (see paragraph 24).
Conclusion – A provision is recognised for the best estimate of the costs of refunds (see paragraphs 10 (the definition of a constructive obligation), 14, 17 and 24).
On 12 December 20X0 the board of an entity decided to close down a division. Before the end of the reporting period (31 December 20X0) the decision was not communicated to any of those affected and no other steps were taken to implement the decision.
Present obligation as a result of a past obligating event – There has been no obligating event and so there is no obligation.
Conclusion – No provision is recognised (see paragraphs 14 and 72).
On 12 December 20X0, the board of an entity decided to close down a division making a particular product. On 20 December 20X0 a detailed plan for closing down the division was agreed by the board; letters were sent to customers warning them to seek an alternative source of supply and redundancy notices were sent to the staff of the division.
Present obligation as a result of a past obligating event – The obligating event is the communication of the decision to the customers and employees, which gives rise to a constructive obligation from that date, because it creates a valid expectation that the division will be closed.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognised at 31 December 20X0 for the best estimate of the costs of closing the division (see paragraphs 14 and 72).
Under new legislation, an entity is required to fit smoke filters to its factories by 30 June 20X1. The entity has not fitted the smoke filters.
(a) | At 31 December 20X0, the end of the reporting period |
Present obligation as a result of a past obligating event – There is no obligation because there is no obligating event either for the costs of fitting smoke filters or for fines under the legislation.
Conclusion – No provision is recognised for the cost of fitting the smoke filters (see paragraphs 14 and 17–19).
(b) | At 31 December 20X1, the end of the reporting period |
Present obligation as a result of a past obligating event – There is still no obligation for the costs of fitting smoke filters because no obligating event has occurred (the fitting of the filters). However, an obligation might arise to pay fines or penalties under the legislation because the obligating event has occurred (the non‑compliant operation of the factory).
An outflow of resources embodying economic benefits in settlement – Assessment of probability of incurring fines and penalties by non‑compliant operation depends on the details of the legislation and the stringency of the enforcement regime.
Conclusion – No provision is recognised for the costs of fitting smoke filters. However, a provision is recognised for the best estimate of any fines and penalties that are more likely than not to be imposed (see paragraphs 14 and 17–19).
The government introduces a number of changes to the income tax system. As a result of these changes, an entity in the financial services sector will need to retrain a large proportion of its administrative and sales workforce in order to ensure continued compliance with financial services regulation. At the end of the reporting period, no retraining of staff has taken place.
Present obligation as a result of a past obligating event – There is no obligation because no obligating event (retraining) has taken place.
Conclusion – No provision is recognised (see paragraphs 14 and 17–19).
[Deleted]
[Deleted]
After a wedding in 20X0, ten people died, possibly as a result of food poisoning from products sold by the entity. Legal proceedings are started seeking damages from the entity but it disputes liability. Up to the date of authorisation of the financial statements for the year to 31 December 20X0 for issue, the entity’s lawyers advise that it is probable that the entity will not be found liable. However, when the entity prepares the financial statements for the year to 31 December 20X1, its lawyers advise that, owing to developments in the case, it is probable that the entity will be found liable.
(a) | At 31 December 20X0 |
Present obligation as a result of a past obligating event – On the basis of the evidence available when the financial statements were approved, there is no obligation as a result of past events.
Conclusion – No provision is recognised (see paragraphs 15 and 16). The matter is disclosed as a contingent liability unless the probability of any outflow is regarded as remote (paragraph 86).
(b) | At 31 December 20X1 |
Present obligation as a result of a past obligating event – On the basis of the evidence available, there is a present obligation.
An outflow of resources embodying economic benefits in settlement – Probable.
Conclusion – A provision is recognised for the best estimate of the amount to settle the obligation (paragraphs 14–16).
Some assets require, in addition to routine maintenance, substantial expenditure every few years for major refits or refurbishment and the replacement of major components. IAS 16 Property, Plant and Equipment gives guidance on allocating expenditure on an asset to its component parts where these components have different useful lives or provide benefits in a different pattern.
A furnace has a lining that needs to be replaced every five years for technical reasons. At the end of the reporting period, the lining has been in use for three years.
Present obligation as a result of a past obligating event – There is no present obligation.
Conclusion – No provision is recognised (see paragraphs 14 and 17–19).
The cost of replacing the lining is not recognised because, at the end of the reporting period, no obligation to replace the lining exists independently of the company’s future actions—even the intention to incur the expenditure depends on the company deciding to continue operating the furnace or to replace the lining. Instead of a provision being recognised, the depreciation of the lining takes account of its consumption, ie it is depreciated over five years. The re‑lining costs then incurred are capitalised with the consumption of each new lining shown by depreciation over the subsequent five years.
An airline is required by law to overhaul its aircraft once every three years.
Present obligation as a result of a past obligating event – There is no present obligation.
Conclusion – No provision is recognised (see paragraphs 14 and 17–19).
The costs of overhauling aircraft are not recognised as a provision for the same reasons as the cost of replacing the lining is not recognised as a provision in example 11A. Even a legal requirement to overhaul does not make the costs of overhaul a liability, because no obligation exists to overhaul the aircraft independently of the entity’s future actions—the entity could avoid the future expenditure by its future actions, for example by selling the aircraft. Instead of a provision being recognised, the depreciation of the aircraft takes account of the future incidence of maintenance costs, ie an amount equivalent to the expected maintenance costs is depreciated over three years.
Two examples of the disclosures required by paragraph 85 are provided below.
| Example 1 Warranties |
|---|
| A manufacturer gives warranties at the time of sale to purchasers of its three product lines. Under the terms of the warranty, the manufacturer undertakes to repair or replace items that fail to perform satisfactorily for two years from the date of sale. At the end of the reporting period, a provision of 60,000 has been recognised. The provision has not been discounted as the effect of discounting is not material. The following information is disclosed: A provision of 60,000 has been recognised for expected warranty claims on products sold during the last three financial years. It is expected that the majority of this expenditure will be incurred in the next financial year, and all will be incurred within two years after the reporting period. |
| Example 2 Decommissioning costs |
|---|
| In 2000, an entity involved in nuclear activities recognises a provision for decommissioning costs of 300 million. The provision is estimated using the assumption that decommissioning will take place in 60–70 years’ time. However, there is a possibility that it will not take place until 100–110 years’ time, in which case the present value of the costs will be significantly reduced. The following information is disclosed: A provision of 300 million has been recognised for decommissioning costs. These costs are expected to be incurred between 2060 and 2070; however, there is a possibility that decommissioning will not take place until 2100–2110. If the costs were measured based upon the expectation that they would not be incurred until 2100–2110 the provision would be reduced to 136 million. The provision has been estimated using existing technology, at current prices, and discounted using a real discount rate of 2 per cent. |
An example is given below of the disclosures required by paragraph 92 where some of the information required is not given because it can be expected to prejudice seriously the position of the entity.
| Example 3 Disclosure exemption |
|---|
| An entity is involved in a dispute with a competitor, who is alleging that the entity has infringed patents and is seeking damages of 100 million. The entity recognises a provision for its best estimate of the obligation, but discloses none of the information required by paragraphs 84 and 85 of the Standard. The following information is disclosed: Litigation is in process against the company relating to a dispute with a competitor who alleges that the company has infringed patents and is seeking damages of 100 million. The information usually required by IAS 37 Provisions, Contingent Liabilities and Contingent Assets is not disclosed on the grounds that it can be expected to prejudice seriously the outcome of the litigation. The directors are of the opinion that the claim can be successfully resisted by the company. |