Module 13

PAS 37 – Provisions, Contingent Liabilities and Contingent Assets

Introduction

Philippine Accounting Standards 37 prescribes the accounting and disclosure requirements for
provisions, contingent liabilities and contingent assets to help users understand their nature, timing
and amount.

PAS 37 applies to the accounting for provisions, contingent liabilities and contingent assets, except
those arising from executory contract, unless they are onerous, and those that are covered by other
PFRSs.

Learning outcomes:
1. State the recognition criteria for provisions.
2. Differentiate the accounting requirements for a provision, a contingent liability and a
contingent asset.
3. Describe the measurement of a provision.

Objective of PAS 37

The objective of PAS 37 is to ensure that appropriate recognition criteria and measurement bases
are applied to provisions, contingent liabilities and contingent assets and that sufficient information
is disclosed in the notes to the financial statements to enable users to understand their nature,
timing and amount. The key principle established by the Standard is that a provision should be
recognized only when there is a liability i.e. a present obligation resulting from past events. The
Standard thus aims to ensure that only genuine obligations are dealt with in the financial statements
– planned future expenditure, even where authorized by the board of directors or equivalent
governing body, is excluded from recognition.

Scope
IAS 37 excludes obligations and contingencies arising from:

• financial instruments that are in the scope of IAS 39 Financial Instruments: Recognition
and Measurement (or IFRS 9 Financial Instruments)
• non-onerous executory contracts
• Insurance contracts (see IFRS 4 Insurance Contracts), but IAS 37 does apply to other
provisions, contingent liabilities and contingent assets of an insurer
• items covered by another IFRS. For example, IAS 11 Construction Contracts applies to
obligations arising under such contracts; IAS 12 Income Taxes applies to obligations for

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 current or deferred income taxes; IAS 17 Leases applies to lease obligations; and IAS 19
Employee Benefits applies to pension and other employee benefit obligations.

Provisions:
• A provision is a liability of uncertain timing or amount.
• Provisions differ from other liabilities because of the uncertainty about the timing or
amount of expenditure required in settlement. Unlike for other liabilities, provisions must
be estimated.
• Although, some other liabilities are also estimated, their uncertainty is generally much less
than for provisions.
• Other liabilities, such as accruals, are reported as part of “Trade and other payables”
whereas provisions are reported separately.

Contingent liability:
• A possible obligation depending on whether some uncertain future event occurs, or
• A present obligation but payment is not probable or the amount cannot be measured
reliably

Contingent asset:
• A possible asset that arises from past events, and
• Whose existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the entity.

Provision vs. Contingent liability

Recognition of provisions

A provision is recognized when all of the following conditions are met:

a. The entity has a present obligation (legal or constructive) as a result of a past event;
b. It is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; and
c. A reliable estimate can be made of the amount of the obligation.

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 An obligating event is an event that creates a legal or constructive obligation and, therefore, results
in an entity having no realistic alternative but to settle the obligation.

A constructive obligation arises if past practice creates a valid expectation on the part of a third
party, for example, a retail store that has a long-standing policy of allowing customers to return
merchandise within, say, a 30-day period.

A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is
not required if payment is remote.

In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present
obligation. In those cases, a past event is deemed to give rise to a present obligation if, taking
account of all available evidence, it is more likely than not that a present obligation exists at the
balance sheet date. A provision should be recognized for that present obligation if the other
recognition criteria described above are met. If it is more likely than not that no present obligation
exists, the entity should disclose a contingent liability, unless the possibility of an outflow of
resources is remote.

Measurement

The amount recognized as a provision should be the best estimate of the expenditure required to
settle the present obligation at the balance sheet date, that is, the amount that an entity would
rationally pay to settle the obligation at the balance sheet date or to transfer it to a third [Link]
means:

• Provisions for one-off events (restructuring, environmental clean-up, settlement of a

lawsuit) are measured at the most likely amount.
• Provisions for large populations of events (warranties, customer refunds) are measured at
a probability-weighted expected value.

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 • Both measurements are at discounted present value using a pre-tax discount rate that
reflects the current market assessments of the time value of money and the risks specific to
the liability.

In reaching its best estimate, the entity should take into account the risks and uncertainties that
surround the underlying events.

If some or all of the expenditure required to settle a provision is expected to be reimbursed by

another party, the reimbursement should be recognized as a separate asset, and not as a reduction
of the required provision, when, and only when, it is virtually certain that reimbursement will be
received if the entity settles the obligation. The amount recognized should not exceed the amount
of the provision.

In measuring a provision consider future events as follows:

• forecast reasonable changes in applying existing technology
• ignore possible gains on sale of assets
• consider changes in legislation only if virtually certain to be enacted

Present value
Where the effect of the time value of money is material, the amount of a provision shall be the
present value of the expenditures expected to be required to settle the obligation.

Expected disposal of assets

Gains from the expected disposal of assets shall not be taken into account in measuring a provision.
Gains shall be recognized only when the assets are actually disposed of.

Reimbursements
Where some or all of the expenditure required in settling a provision is expected to be reimbursed
by another party, the reimbursement is recognized only when it is virtually certain that
reimbursement will be received if the entity settles the obligation.

The reimbursement shall be treated as a separate asset.

In the statement of profit or loss and other comprehensive income, the expense relating to a
provision may be presented net of the amount recognized for a reimbursement.

Changes in provisions

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 • Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the
current best estimate.
• If it is no longer probable that an outflow of resources embodying economic benefits will
be required to settle the obligation, the provision shall be reversed.

Product warranties and guarantees

If a customer has the option to purchase a warranty separately (for example, because the warranty
is priced or negotiated separately), the warranty is accounted for in accordance with PFRS 15
Revenue from Contracts with Customers.

If a customer does not have the option to purchase a warranty separately, the warranty is accounted
for in accordance with PAS 37 Provisions, Contingent Liabilities and Contingent Assets unless the
promised warranty provides the customer with a service in addition to the assurance that the
product complies with agreed-upon specifications.

Liability for premiums

A customer option to acquire additional goods or services for free or at a discount is accounted for
under PFRS 15 if the option provides the customer a material right that the customer would not
receive without entering into that contract.

A customer option that does not provide the customer with a material right is not accounted for
under PFRS 15; and therefore, accounted for in accordance with PAS 37.

Guarantee for indebtedness of others

A provision for the guarantee for indebtedness of others is recognized when it becomes probable
that the entity will be held liable for the guarantee, such as when the original debtor defaults on
the loan.

Contingent assets
Contingent assets should not be recognised – but should be disclosed where an inflow of economic
benefits is probable. When the realisation of income is virtually certain, then the related asset is
not a contingent asset and its recognition is appropriate.

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 Disclosures:
Reconciliation for each class of provision:
• opening balance
• additions
• used (amounts charged against the provision)
• unused amounts reversed
• unwinding of the discount, or changes in discount rate
• closing balance
• A prior year reconciliation is not required. [IAS 37.84]

For each class of provision, a brief description of:

• Nature
• Timing
• Uncertainties
• Assumptions
• Reimbursement, if any.

References:

Millan, Z. V. (2018). PAS 37 Provisions, Contingent Liabilities and Contingent Assets: In

Conceptual Framework and Accounting Standards (2018 Edition, pp. 393-402). Bandolin
Enterprise.

IAS 37- Provisions, Contingent Liabilities and Contingent Assets

2020).[Link]

Activity:
Answer Problem 1 and Problem 2, PAS 37 Provisions, Contingent Liabilities and Contingent
Assets (pp. 402-403) in your textbook.

THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF
REPRODUCTION, DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT THE
WRITTEN PERMISSION OF THE UNIVERSITY IS STRICTLY PROHIBITED.
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