Accounting for liabilities in accordance with IAS 37, IAS 17 and IAS 19 Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB, 30 April to 4 May 2012

IAS 37 Provisions, Contingent Liabilities and Contingent Assets MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Introduction IAS 37 applies to all provisions and contingent liabilities except for: those that result from executory contracts unless the contract is onerous; and those covered by another IFRS (ie income taxes and employee benefits). IAS 37 does not apply to financial instruments within the scope of IFRS 9. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Measurement of provisions A provision is measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. risks and uncertainties are taken into account in the measurement of a provision. if measured using risk adjusted cash flow forecasts a provision is discounted to its present value. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Measurement of provisions continued 5 Measure provision at ‘best estimate’ of the amount required to settle the obligation at the reporting date, ie amount an entity would rationally pay to settle the obligation at the end of the reporting period; or to transfer it to a third party at that time Review provisions at each reporting date and adjust them to reflect the current best estimate at that reporting date unwinding of the discount is a finance cost © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 5

Measurement of provisions continued 6 If large population of items, best estimate reflects probability weighting of all possible outcomes. If single obligation, best estimate is the adjusted individual most likely outcome Present value using pre-tax discount rate/s that reflect current market assessments of the time value of money (& risks specific to the liability if not already reflected in estimated cash flows). © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 6

Examples—measurement of provisions 7 Ex 1: A has 1,000 units of a product sold with active warranties (ie A will repair defects found up to 6 months after sale). Probabilities & repair cost: major defect = 5% chance of CU400 repair; minor defect = 20% chance of CU100 repair; 75% chance of no defects. Best estimate (expected value) = CU40,000 Calculation: (75% x 1,000 units x nil) + (20% x 1,000 units x CU100) + (5% x 1,000 units x CU400) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 7

Examples—measurement of provisions continued 8 Ex 2: Personal injury lawsuit brought by customer. Lawyers estimate 30% chance compensation = CU2,000,000 & 70% chance = CU300,000. Ruling expected in 2 years. Discount rate = 4% per year (ie 2‑year government bonds = 5% less 1% risks specific to liability). Individual most likely outcome = CU300,000. Because only other possible outcome is higher, the best estimate to settle the obligation at 31/12/20X1 will be higher than PV of the most likely outcome of CU300,000, eg PV of CU810,000 at 4% = ±CU748,890 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 8

Examples—measurement of provisions continued 9 Ex 3: Provision for a lawsuit = CU40,000 at 31/12/20X1 & remeasured to CU90,000 at 31/12/20X2. CU3,000 of the increase = unwinding of the discount & the remainder is for better information becoming available. The increase of CU50,000 will be recognised as an expense in the determination of the entity’s profit or loss for the year ended 31/12/20X2 CU3,000 = finance cost CU47,000 = change in estimate © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 9

Disclosure exception When disclosure of some or all information normally required by IAS 37 can be expected to prejudice seriously the position of the entity in a dispute then disclose only general nature of the dispute and reason why alternative disclosures made. Note: no recognition and measurement alternative. such a situation is expected to be an extremely rare case. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Comparison to the IFRS for SMEs IAS 37 and Section 21 Provisions and Contingencies of the IFRS for SMEs share similar principles, but the IFRS for SMEs is drafted in simplified language. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates Measuring a provision requires estimating the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. the risks and uncertainties that inevitably surround many events and circumstances are taken account in measuring a provision (eg measure a provision at its expected value by weighing all possible outcomes by their associated probabilities). MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IAS 17 Leases MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Introduction A lease is an agreement that conveys to the lessee a right to use an asset for a period of time. For accounting purposes, leases are classified as finance leases or operating leases. finance leases are accounted for as in- substance purchases (ie recognise the asset ‘acquired’ (eg PPE) and the obligation to make lease payments—a liability) operating leases are accounted for as executory contacts—generally no asset/liability recognition WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Scope Applied to all leases other than: leases for resource exploration; and licencing agreements for certain items (eg plays) IAS 17’s measurement requirements are not applied to: lessee-held property accounted for as Investment Property investment property provided under an operating lease biological assets held under finance leases biological assets provided under an operating lease WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Operating leases The leased asset remains in the statement of financial position of the lessor. Operating lease payments are usually recognised in profit or loss on a straight-line basis. From the perspective of the lessee, if payments are subject to escalation, straight-line recognition is profit or loss may give rise to a liability on the statement of financial position the liability reduces as future payments are made WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Examples—operating leases 17 Ex 1: On 1/1/20X1 A entered into a 5-year non‑cancellable operating lease over a building. Rentals X1–X4 = 0. Rental X5 = 5,000. Ex 2: Same as Ex 1 except lessor agrees to pay the lessee’s relocation costs (ie 500) as an incentive to the lessee for entering into the new lease Ex 3: Operating lease payments increase by expected CPI (10% p.a.) to compensate the lessor for expected inflation. X1 = 1,000; X2 = 1,100; X3 = 1,210; etc © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Finance leases Finance leases are accounted for by lessees as an asset purchased (other IFRSs then apply to the asset) on credit (a liability). Initially, the liability is recognised at: the fair value of the leased property, or if lower the present value of the minimum lease payments—the implicit interest rate is used as the discount rate Lease payments are apportioned between a reduction in the lease liability and interest expense. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example—finance lease 19 On 1/1/20X1 enter into 5-yr non‑cancellable lease over a machine. Machine’s cash cost = 100,000, economic life = 10 yrs and residual value = 0. Annual lease payments on 31/12: 4 × 23,000 & 23,539 at end of yr 5 when ownership transfers to the lessee. The interest rate implicit in the lease is 5% p.a. which approximates lessee’s incremental borrowing rate. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example—finance lease continued 20 Finance lease obligation amortisation table: 1 Jan Finance cost Payment 31 Dec 20X1 100,000 5,000 (23,000) 82,000 20X2 4,100 63,100 20X3 3,155 43,255 20X4 2,163 22,418 20X5 1,121 (23,539) – 15,539 115,539 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Example—finance lease continued 21 1/1/20X1 (initial recognition) recognise: asset (PPE) 100,000; and liability (finance lease obligation) 100,000 For the year ended 31/12/20X1 recognise: allocate payment of 23,000 (5,000 finance cost in profit or loss & 18,000 repayment of finance lease obligation) CU10,000 depreciation expense in profit or loss and as a reduction to the asset © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Sale and leaseback 22 A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. the lease payment & the sale price are usually interdependent because they are negotiated as a package the accounting treatment of a sale and leaseback transaction depends on the type of lease (finance or operating). © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 22

Recognition of sale & finance leaseback 23 the seller-lessee defers recognition of income (ie does not recognise any excess of sales proceeds over the carrying amount in profit or loss immediately) Deferred income is recognised in profit or loss over the lease term © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 23

Recognition of sale & operating leaseback by seller-lessee 24 if at FV, recognise profit or loss immediately if SP < FV & lease payments not adjusted, recognise profit or loss immediately if SP < FV & lease payments are adjusted, defer & amortise such loss in proportion to the lease payments over the period for which the asset is expected to be used. If SP > FV defer the excess over fair value and amortise it over the period for which the asset is expected to be used. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 24

Comparison to the IFRS for SMEs Section 20 Leases of the IFRS for SMEs does not require lease payments in an operating lease that are structured to increase in line with expected general inflation to be recognised by the lessee or lessor on a straight-line basis, unlike IAS 17. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates Identifying arrangements that contain a lease Classifying a lease—finance or operating lease Determining the interest rate implicit in a lease (particularly for a lessee) For manufacturer or dealer lessors, bifurcating the sale and financing transactions. WU © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IAS 19 Employee Benefits MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Introduction IAS 19 specifies accounting for and disclosure of employee benefits by employers. It is applied by an employer in accounting for all employee benefits, except those to which IFRS 2 Share-based Payment applies. Information about employee benefits expenses and obligations can help users assess the extent and uncertainty of an entity’s future employee benefit cash outflows. Uncertainties can be significant (eg some pension promises). MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Employee benefits Employee benefits are all forms of consideration paid for services of employees or for termination of employment. IAS 19 separates employee benefits into four categories: short-term benefits post-employment benefits other long-term benefits termination benefits MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Short-term employee benefits Short-term employee benefits are expected to be settled wholly before 12 months after the period in which the employee rendered the related service. recognise as an expense as the employee provides the related service measure obligations at undiscounted amounts (application of the cost constraint) no disclosures specified in IAS 19. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Examples— short-term employee benefits 31 Ex 1: An employee is entitled to 5 days paid sick leave a year. Unused sick leave is carried forward for 1 calendar year. It is allocated on a FIFO basis. No sick leave is expected to lapse. Employee 1 earns 400 per working day. Sick leave record: 4.5 days accumulated at 1/1/20X1; 2 days taken in 20X1. Salary increase = 5% effective 1/1/20X2. 31/12/20X1 liability = CU2,100 (ie CU400 wage rate × 1.05 increase × 5 (max) days due at 31/12/20X1 & expected to be taken in 20X2. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 31

Examples— short-term employee benefits 32 Ex 2: Same as Ex 1 except sick leave cannot be carried forward to the next calendar year & does not vest (ie is not paid out in cash). No liability at 31/12/20X1 (no obligation). Ex 3: Similar to Ex 1 and Ex 2 except sick leave is paid out in cash in January 20X2 payroll at 20X1 salary rate. 31/12/20X1 liability = CU1,200 (ie CU400 wage rate × 3 (5 earned less 2 taken) days due at 31/12/20X1 & paid out in 20X2. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 32

Examples— short-term employee benefits 33 Ex 4: A pays 3% of year’s profit (before profit sharing) to employees who serve throughout the current year & who will continue to serve throughout the following year. A expects to save 10% through staff turnover. The bonus will be paid on 31/12/20X2. Profit for 20X1 before profit sharing = CU1,000,000. Liability at 31/12/20X1 & expense = CU27,000 (ie 3% × CU1,000,000 × 90%) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 33

Post-employment benefits Post-employment benefits are payable after the completion of employment. Two types: defined contribution plan, entity pays fixed contributions to a separate entity (a fund) and has no legal or constructive obligation to pay further contributions if the fund cannot pay the employee. all other post-employment plans are defined benefit plans. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Post-employment benefits—defined contribution Employees (not the employer) are exposed to risks. Employer: recognises contributions payable as an expense as the employee provides services in exchange for the contributions. measures obligations for unpaid contributions at undiscounted amounts (application of the cost constraint). disclose amount recognised as an expense. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Post-employment benefits—defined benefit Recognise the defined benefit liability as follows: use the projected unit credit method based on actuarial assumptions to measured the obligation at its present value; less the fair value of plan assets (if any). Recognise all changes in the defined benefit liability (asset) when they occur: service costs and net interest in profit and loss remeasurements in other comprehensive income. Extensive disclosures specified. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Other long-term benefits Other long-term benefits are all employee benefits other than short-term employee benefits, post-employment benefits and termination benefits Recognition and measurement is the same as that for post-employment benefits: defined benefit plans. No disclosures specified in IAS 19. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Termination benefits Termination benefits arise only on termination, rather than during employment. principle—the event that gives rise to an obligation is the termination of employment rather than employee service Recognise expense and a liability at the earlier of: when the entity can no longer withdraw the offer of those benefits when the entity recognises the related restructuring provision in accordance with IAS 37. No disclosures specified in IAS 19. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Comparison to the IFRS for SMEs The primary differences between IAS 19 and Section 28 Employee Benefits are: Section 28 allows simplification of measurement principles meaning that external specialists may not need to be engaged (ie full application of the projected unit credit method may not be required) less detailed disclosures are required MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates 40 To measure the liability for a defined benefit post-employment plan (eg mortality, employee turnover, age at and date of retirement, future salary and benefit levels, future medical costs, the discount rate and fair value of plan assets). extensive disclosures required to: explain characteristics of the plan and associated risks; identify and explain related amounts in financial statements; possible affects on the amount, timing and uncertainty of future cash flows. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Judgements and estimates continued 41 Measuring obligations for profit-sharing plans often require estimates of expected payments to employees and expected forfeitures if loyalty period applies. Accumulating compensated absence schemes (eg some sick leave, holiday leave, maternity leave, military leave and long-service leave schemes) require estimates of expected employee compensated absences. MW © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

Questions or comments? Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org 42

43 43 The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January 2012 but not the IFRSs they will replace. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org 43