Impact of COVID 19 on Ind AS 37
Onerous contracts are those contracts for which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. Unavoidable costs under a contract are 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 fulfil it.
As a result of COVID -19, some contracts may become onerous for reasons such as increase in cost of material / labour, etc. Management should consider whether any of its contracts have become onerous. The same should be accounted for as per Ind AS 37. Ind AS 37 also requires assets dedicated to a contract to be tested for impairment before a liability for an onerous contract is recognized.
If the management is unable to assess whether some of the executory contracts are onerous due to inadequacy of information, the same should be disclosed. Management should disclose that it has assessed whether executory contracts are onerous due to the adverse impact of COVID -19. If, the management is unable to assess whether some of the executory contracts have become onerous due to inadequacy of information, the same should be disclosed.
Recognizing a Provision:
Ind AS 37 requires a provision to be recognized only
- where an entity has a present obligation
- it is probable that an outflow of resources is required to settle the obligation; and
- a reliable estimate can be made.
Due to COVID-19, there is a need for exercising judgment in making provisions for losses and claims. A provision may be accounted for only to the extent that there is a present obligation for which the outflow of economic benefits is probable and can be reliably estimated.
Contingent asset / Insurance Claims
Entities may have insurance policies that cover loss of profits due to business disruptions due to events like COVID-19. Entities claims on insurance companies can be recognized in accordance with Ind AS 37 only if the recovery is virtually certain i.e. the insurance entities have accepted the claims and the insurance entity will meet its obligations.
One of the steps taken to control the spread of the virus is to require some businesses to close temporarily. An entity might have business continuity insurance and be able to recover some or all of the costs of closing. Management should consider whether the losses arising from COVID-19 are covered by its insurance policies. The benefit of such insurance is recognized when the recovery is virtually certain. This is typically when the insurer has accepted that there is a valid claim and management is satisfied that the insurer can meet its obligations. The benefit of insurance is often recognized later than the costs for which it compensates.
When we are concluding that the potential recovery of insurance proceeds is virtually certain, it will include significant judgment and it should incorporate evaluating all relevant facts and information available. The right to reimbursement is recognized as a separate asset (no netting off with the provision itself), but one can net off the expenses for provision with the income from reimbursement in the profit or loss.
Future operating loss:
Ind AS 37 does not permit provisions for future operating costs or future business recovery costs. However, Ind AS 37 requires that an entity should disclose the nature of the obligation and the expected timing of the outflow of economic benefits which becomes extremely relevant and helpful for the users of the financials amid Covid 19 situation.
Restructuring plan costs:
Due to Covid 19 related events and circumstances, a company might plan or start a restructuring plan. The Standard provides that a provision for restructuring costs is recognized only when the general recognition criteria for provisions are met and when there is a detailed formal plan for the restructuring and there is evidence that the entity has started to implement a restructuring plan, for example, by dismantling plant or selling assets or by the public announcement of the main features of the plan.