ias 37 provisions examples

In this post, we will see a series of examples of provisions under IAS 37.

These examples include legal provisions, implicit, recognition of a provision by enacting a law, provisions with a wide range of likely outcomes, and provisions with a higher individual outcome.

IAS 37 provision examples of legal obligation:

 
 

waste from the production process of an entity contaminated the waters of a community.

The entity is required by law to recover the contaminated environment.

It is estimated that such recovery will cost between 200,000 and 400,000.

The law requires the entity to recover the affected area within 3 to 5 years

IAS 37 establishes that a provision can be legal or implicit.

A legal obligation derives from:

  • A contract (through its explicit or implicit terms)
  • Legislation, or
  • other operation of law 
 

And an implicit type of obligation derives from the actions of the entity itself, in which:

There is a pattern of past practice, published policies, or a sufficiently specific current statement in where the entity has indicated to other parties that it will accept certain responsibilities; and

as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities

The example we are analyzing corresponds to a legal provision because a law obliges the entity to recover the environment.

The entity must recognize a provision because the date and amount of future disbursements that an entity must incur to recover the waters of the community are unknown.

To recognize a provision, there must be uncertainty about the date or the amount of the outflow of resources.

In the example we will carry out below, we will see an implicit type of obligation.

IAS 37 provision examples implicit obligation

 
 
As part of its social responsibility policy, an entity has been providing houses to the community of a city for 10 years.

The houses demand of this population will determine the resources the company must disburse in the future.

This example corresponds to an implicit type of obligation because no law, norm, or some body obliges the entity to make these disbursements of resources.

In other words, the disbursements of these resources are determined by a business policy with a pattern of behavior in the past.

On the other hand, the example corresponds to a provision because each year, the budget to carry out this social function is different.

In other words, the amount of resources the entity must disburse is unknown.

IAS 37 provision examples recognition of a provision as a result of the enactment of a law

Before continuing to read the post, put your knowledge into practice.

IAS 37 QUESTIONS

An entity has a recycling plant.

The noise emissions emitted by this plant affect a community’s tranquility.

No law sanctions these practices; however, next year, the approval of a law that imposes a fine of 500,000 dollars for noise pollution is imminent.

IAS 37 establishes that a provision can only be recognized if there is a present obligation.

In this case, there is no present obligation; therefore, in theory, the entity should not recognize a provision in this example.

However, paragraph 21 of IAS 37 establishes an exception to recognizing a present obligation.

This exception establishes that the company must recognize a provision when there are legal changes, such as the approval of a law that obliges an entity to disburse certain resources to correct the damages caused to a third party.

IAS 37 provision examples due to a large number of similar obligations

 
 

In January of year 1, an entity is sued by a group of employees who consider that their labor rights have been violated.

The demands of the workers are divided into four parts:

25% requires a payment of 20,000

30% requires a payment of 30,000

35% requires a payment of 25,000

10% requires a payment of 35,000

The trial will take place in December of year 3.

The discount rate is 11%.

Paragraph 39 of IAS 37 establishes that Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities.

In this example, the entity must recognize a provision of 19,201, which is the result of the following operation.

Provision 1: 25% X 20,000 = 5,000

Provision 2: 30% X 30,000 = 9,000

Provision 3: 35% X 25,000 = 8,750

Provision 4: 10% X 35,000 = 3,500

Total provision: 26,260.

Present value obligation: (1+11%) ^-3x 26,260 = 19,201

IAS 37 provision examples when there are possible outcomes are either mostly higher or mostly lower than the most likely outcome

 
 

An entity is sued by a group of customers who believe that the products sold by the entity caused harm to their health.

75% of clients request a compensation of 200,000, while 25% request a payment of 1,200,000.

In this case, an entity must review paragraph 40 of IAS 37, which establishes that an entity may consider the individual most likely outcome.

That is, recognize a provision of 200,000.

However, this paragraph establishes that when individual results are much higher than the other results, an entity must prioritize these results over the probability of occurrences.

So, in this case, an entity should recognize a provision of 1,200,000 regardless of whether it is not the most likely outcome.

This is so because if the entity recognizes a provision of 200,000, it would be undervaluing the provision associated with this uncertainty.

IAS 37 QUESTIONS

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