Objectives and Scope – Ind AS 37
Introduction to Ind AS 37
- Ind AS 37 Provisions, contingent liabilities and contingent assets outlines the accounting for provisions (liabilities of uncertain timing or amount), together with contingent assets (possible assets) and contingent liabilities (possible obligations)
- Provisions are measured at the best estimate (including risks and uncertainties) of the expenditure required to settle the present obligation and reflect the present value of expenditures required to settle the obligation when the time value of money is material
Objectives of IND AS 37:
The objectives of this Standard are
- to ensure that appropriate recognition criteria is applied to provisions, contingent liabilities and contingent assets
- to ensure that appropriate measurement bases are applied to provisions, contingent liabilities and contingent assets and
- sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount.
- This Standard Ind AS 37 is applicable by all entities in accounting for provisions, contingent liabilities and contingent assets except:
- Provisions, contingent liabilities and contingent assets resulting from executory contracts unless they are onerous;
- Those covered by another standards such as IND AS 12, 19, 104, 103, 115, 116 (unless lease or contract is onerous under IND AS 115, 116)
- Financial instruments as they are covered within the scope of IND AS 109
- Depreciation, impairment of assets and doubtful debts.
Executory Contracts Meaning:
- Executory contracts are contracts under which
- neither party has performed any of its obligations or
- both parties have partially performed their obligations to an equal extent
Example 1: Example of Executory Contracts:
Facts: On January 1, 2020, Company A enters into a contract with Company B for the manufacturing and delivery of 100 units of Component Q each at 5 different dates in future. i.e. 500 units are to be delivered in total. Payment is due on delivery of the units.
Explanation of executory contracts in this case:
On January 1, 2020, the contract between Company A and Company B is executory because neither party has performed any of its obligations; Company B has not manufactured or delivered any of the units not Company B has paid for any of them.
By 1 March 2020, Company B has produced and delivered 200 of the units and Company A has paid in full for those 200 units. At this date, the contract is executory because both parties have partially performed their obligations to an equal extent.
By June 1, 2020, Company B has produced and delivered the full 500 units, but Company A has only paid for 400 units in total. The contract between Company A and Company B no longer meets the definition of an executory contract because the two parties have not performed under the terms of the contract to an equal extent. Company A is required to recognize a liability for the final 100 units of Component Q for which it has not yet paid.
Background of “Provision” Standard
- The definition of a “provision” is key to the standard.
- A provision is a liability of uncertain timing or amount, meaning that there is some question over either how much will be paid or when this will be paid. In the past, these uncertainties may have been exploited by companies trying to ‘smooth profits’ in order to achieve the results they believe that their various stakeholder may want.
- For example, at the start of the year, ABC Limited sets a profit target of Rs. 500M for the year ended 31st March 2020
- The chief accountant of ABC Limited has reviewed the profit to date and realizes they are likely to achieve profits of Rs. 550M
- The accountant knows that if ABC Limited reports a profit of Rs. 550M, directors /KMP will not get any more of a bonus than if they reported Rs. 500M
- He also knows that the profit target will be set upwards at Rs. 600M for the next year
- To avoid this, the accountant may be tempted to make some provisions for some potential future expenses of Rs. 50M, with the impact of making the profit seem lower in the current period. As the double entry for a provision is to debit an expense and credit the liability, this would potentially reduce the profit down to Rs. 500M
- Then in the next year, the chief accountant could reverse this provision, by debiting the liability and crediting the profit or loss. This is effectively an attempt to move Rs. 50M profit from the current year into the next period
- Clearly this is not good for the users of the financial statements, as the financial statements would have been manipulated and given a false impression of the performance of the business
- This is where Ind AS 37 is used to ensure that companies report only those provisions that meet certain criteria.