1. AS 29, Provisions, Contingent Liabilities and Contingent Assets

2. Learning objectives
Explain the recognition and measurement criteria for provisions, contingent liabilities and contingent assets
Apply AS 29 to specific circumstances including restructuring
Understanding onerous contracts
Differences with IAS 37

3. Provisions, contingent liabilities and contingent assets
Even though its basic approach is similar to that of AS 4, this standard elucidates and comprehensively deals with the principles of measurement of provisions and contingencies with specific guidelines in situations of restructuring, onerous contracts etc. and makes certain significant departures from AS 4
Recognition criteria has been defined in greater detail.
AS 4 did not elucidate on recognition and measurement criteria for provisions
Departures from AS 4:
Reimbursements
Onerous contracts

4. Applicability Mandatory for all enterprises Exceptions
SMCs and Level II/III non-corporate entities are exempt from disclosure requirements of the standard regarding movement in each class of provisions and certain other disclosures thereof (paras 66 and 67)
All paras of AS 4 dealing with contingencies stand withdrawn except to the extent such paras deal with impairment of assets not covered by other Accounting Standards (e.g. provision for doubtful debt is still covered by AS 4)

5. Exclusion from scope
Does not cover provisions, contingent liabilites or contingent assets:
Resulting from financial instruments that are carried at fair value
Resulting from executory contracts except where the contract is onerous
Arising in insurance enterprises from contracts with policy-holders
Those covered by another standard e.g., depreciation, impairment of assets, construction contracts, employees’ retirement benefits, leases, deferred taxes
While the term "provision" may be used to refer to loan loss allowances or similar impairment estimates, these are not provisions for liabilities but rather adjustments to the measurement of the relevant asset

6. Provision
Provision is required for probable outflow on account of obligations existing on the balance sheet date, provided the amount of the outflow can be estimated reliably
Present obligation as a result of a past event i.e. obligating event
Probable* outflow of resources
Reliable estimate
Present obligation - an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not
An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation
For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.
An outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not.
Examples of provisions which meet the 3 criteria
Warranties
Clean up costs for unlawful environmental damage
Decommissioning costs of oil rig installation to the extent the enterprise is obliged to rectify the damage
Legal obligations normally arise from contracts or legislation.
Possible new legisation is reflected only when it is virtually certain to be enacted. In practice new legislation normally does not give rise to an obligation until it is enacted because of uncertainties with respect to both whether it will be enacted and its final terms
* More likely than not

7. Liabilities, accruals and provisions
Liabilities - present obligations from a past event expected to result in an outflow of resources embodying economic benefits
Accruals - liabilities to pay for goods/services received or supplied but not yet paid or invoiced
Provisions - liabilities
of substantial degree of estimation
A provision is a liability which can be measured only by using a substantial degree of estimation. A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
Para 12
Provisions can be distinguished from other liabilities such as trade payables and accruals because in the measurement of provisions substantial degree of estimation is involved with regard to the future expenditure required in settlement. By contrast:
trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and
accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees. Although it is sometimes necessary to estimate the amount of accruals, the degree of estimation is generally much less than that for provisions.

8. Measurement of provisions
Best estimate of expenditure
Should not be discounted to present value
Uncertainty does not justify creation of excessive provisions or deliberate overstatement of liabilities
If there is a large population, such as for product warranties, then the provision is measured at its expected value. Expected value considers all possible outcomes weighted based on their probabilities. If there is a continuous range of possible outcomes, and each point in the range is equally likely, then a provision is recognised for the mid-point in the range.
If there is a single item, then the most likely outcome usually is the best estimate. For example, if there is a 60 percent probability that D will have to pay damages of 600,000 in a legal case and a 40 percent probability that the claim against D will be dismissed, then the provision is measured at 600,000 because D will either win (and pay nothing) or lose and pay 600,000. The provision is not measured at 360,000 (600,000 x 60 percent + 0 x 40 percent).
When a provision is measured at its best estimate, which is less than the amount that could be payable, the difference between the two amounts is not a contingent liability. For example, entity G has an obligation to rectify a fault in a plant constructed for a customer. The provision should be measured based on the expected repair cost, which may be anywhere between 70,000 and 130,000. If the provision is measured at 90,000, then the remaining possible amount of 40,000 is not a contingent liability
Provisions must be remeasured at each reporting date based on the best estimate of the settlement amount. Changes to the best estimate of the settlement amount may result from changes in the amount or timing of the outflows or changes in discount rates.
For those provisions included in the cost of a related asset, the effect of any changes to an existing obligation, including those resulting from changes in the discount rate used, generally are added to or deducted from the cost of the related asset and depreciated prospectively over the asset's useful life
There is not much guidance regarding the types of costs to be included in the measurement of a provision. The accrual of costs that need to be incurred to operate in the future is prohibited. Provisions are measured based on what an entity rationally would pay to settle or transfer the obligation.
In our view, anticipated incremental costs that are related directly to the settlement of a provision should be included in the measurement of the provision to the extent that a third party who assumes the liability would require compensation. This is likely to be the case when the incremental costs are probable and can be estimated reliably.
Incremental costs are those in addition to normal operating expenses. Therefore in our view costs that are not incremental should not be included in the measurement of a provision, even if there is a reasonable basis for allocating a portion of these costs to the settlement of the provision. For example, costs to be incurred irrespective of a specific claim, such as salaries of employees in the claims department, are future operating costs and are excluded from the measurement of a provision.
In our view, the above principle applies to both external and internal costs. However, internal costs often are not incremental and therefore normally would not be included in the measurement of a provision.
For example, entity G maintains a risk management department that handles damage claims. The costs of the department are unlikely to be incremental for any one claim and therefore should not be included in the measurement of the provision for expected claims. However, if G engages an external advisor to negotiate a settlement of a specific matter, then this cost is incremental and normally would be included in the measurement of the related provision.

9. Reimbursements
Reimbursement (< / = provision) recognised only when virtually certain
Treated as a separate asset
Example
Insurance contracts
Indemnity clauses or
Supplier warranties
In some cases, the enterprise will not be liable for the costs in question if the third party fails to pay. In such a case, the enterprise has no liability for those costs and they are not included in the provision.

10. Provision - Examples
Provisions for expected clean up costs when virtually certain that a law requiring cleaning-up of land already contaminated will be enacted
The obligating event is the contamination of the land because of the virtual certainty of legislation requiring cleaning up
Outflow of resources embodying economic benefits in settlement is probable
Conclusion
A provision is recognised for the best estimate of the costs of the clean-up

11. Provision - Examples
An offshore oilfield where its licensing agreement requires removal of the oil rig at end of production and restore seabed. 90% of the costs relate to the removal of the oil rig and restoration of damage caused by building it, and 10% arise through the extraction of oil
At the balance sheet date, the rig has been constructed but no oil has been extracted

12. Provision - Examples
Construction of oil rig is an obligating event. At the balance sheet date, however, there is no obligation to rectify the damage that will be caused by extraction of the oil
An outflow of resources embodying economic benefits in settlement is probable
A provision is recognised for the best estimate of 90% of the costs that relate to the removal of the oil rig and restoration of damage caused by building it. These costs are included as part of the cost of oil rig. The 10% of costs that arise through extraction of oil are recognised as a liability when the oil is extracted

13. Provision - Examples
Under new legislation, an enterprise is required to fit smoke filters to its factories by 30 September The enterprise has not fitted the smoke filters
31 March 2008
There is no obligation because there is no obligating event as at the balance sheet date either for the costs of fitting smoke filters or for fines under the legislation.
No provision is recognised for the cost of fitting the smoke filters

14. Provision - Examples
Under new legislation, an enterprise is required to fit smoke filters to its factories by 30 September 2008; otherwise penalties are prescribed. The enterprise has not fitted the smoke filters
31 March 2009
There is still no obligation for the costs of fitting smoke filters. However an obligation arises to pay fines or penalties under the legislation
No provision is recognised for the costs of fitting smoke filters. However, a provision is recognised for the best estimate of any fines and penalties

15. Reimbursement - Example
Company is informed prior to the issuance of its financial statements that one of its customers won his claim for a defect product delivered in the year under review. No provision had been set up as it was believed that no obligation would occur
However, under the terms of the company’s supplier agreement, the cost of this defect is recoverable from the supplier including an add-on (penalty) of 12%
The claim from the customer as of reporting date amounted to Rs. 3,000,000. The supplier has already indicated that he will reimburse the company as soon as they have paid themselves and has blocked the funds (Rs. 3,360,000) for this purpose

16. Reimbursement - Example
As the three conditions required by AS 29 are met, the company should recognise a provision for loss and disclose nature and amount of obligation
There is also a reimbursement of Rs. 3,360,000 that has been agreed by the supplier and is therefore virtually certain. The reimbursement should be recognised as a separate asset; however, the amount should not exceed Rs. 3,000,000 (para 46). The expense and the reimbursement may be netted off in the income statement (para 47)
The total amount expected from the reimbursement (Rs. 3,360,000) should be disclosed in the notes

17. Contingent liabilities
Present obligation from past events which is not recognised
If resource outflow neither probable nor remote or rare situation or
Where reliable estimate cannot be made
Possible obligation from past events
Existence will be confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within control of the enterprise
Possible obligation - an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable
Where an enterprise is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability.
Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable.
A provision is not recognised for sub-optimal profits. For example, in a regulated industry, good results in one period may result in lower prices being charged in the following period. However, a provision is not recognised in respect of the expected lower revenues because, assuming that the future obligation is not an onerous contract, there is no obligating event.
A provision also may not be recognised for general business risks. Although losses may be probable, and the amount of the expected losses can be estimated, until there is an event of loss there is no obligating event. For example, entity P has announced to the public a business plan. As part of the plan P is entering new markets, including Brazil, Russia and China. The new markets expose P to significant increases in risk, including currency risk and legal and political uncertainties. Although the plan has been made public, and may be virtually certain of being implemented, even if exit strategies are costly, P does not recognise a provision because there is no obligating event
If the outflow is not probable or if in the rare circumstance it cannot be estimated reliably, disclosure of relevant information is required as a contingent liability, unless the possibility of outflow is remote

18. Provisions and contingent liabilities
There is a present obligation that probably requires an outflow of resources and a reliable estimate can be made of the amount of obligation.
There is a possible obligation or a present obligation that may, but probably will not, require an outflow of resources
There is a possible obligation or a present obligation where the likelihood of an outflow of resources is remote.
A provision is recognised
No provision is recognised
Disclosures are required for the provision
Disclosures are required for the contingent liability
No disclosure is required

19. Contingent assets
Possible asset that arises from past events, existence of which will be confirmed only by occurrence or non-occurrence of uncertain future events not wholly within control of the enterprise
NOT ACCOUNTED FOR

20. Recognition criteria – asset, liability or contingency?
Virtually certain
Recognise
Contingent asset
Probable
Possible
Remote
Disclose in report of approving authority
Do not disclose
Estimated Liability
Recognise as provision
Disclose as contingent liability

21. Restructuring
It is a programme that materially changes scope of business or manner in which business is conducted
Provision only when recognition criteria for provisions met
Sale of a line of business
No obligation arises for sale of an operation until binding sale agreement. Provide when binding agreement of sale is entered into
Closure of business locations
Relocation of business activities from one country/region to another
Sale transactions
An obligation related to the sale of an operation arises only when there is a binding sale agreement. Therefore, even though the decision to sell an operation has been announced, no provision is recognised for obligations arising as a result of the sale until there is a binding sale agreement.
Certain sale transactions may be subject to regulatory or shareholder approval. In these cases the sale agreement normally is binding unless the approval is not obtained. In our view, a provision triggered by a sale agreement should be recognised once the agreement is finalised if it is more likely than not that the necessary approval will be obtained.
To the extent that the planned sale of an operation includes non-current assets (or disposal groups), the requirements for assets held for sale are relevant
Restructuring provisions
Restructuring provisions include only incremental costs associated directly with the restructuring. Examples of costs that should be included in measuring the provision include employee termination benefits relating directly to the restructuring, contract termination costs, such as lease termination penalties, and onerous contract provisions, directly related consulting fees, and expected costs from when operations cease until final disposal.
AS prohibits recognition of a provision for costs associated with ongoing activities. Therefore provisions are not recognised for:
• expected future operating costs or expected operating losses unless they relate to an onerous contract;
• gains or losses on expected disposals or impairments of assets;
• investment in new systems;
• lower utilisation of a facility;
• costs of training or relocating staff;
• staff costs for staff that continue to be employed in ongoing operations;
• loyalty bonuses or amounts paid to staff as an incentive to stay;
• costs of moving assets or operations;
• administration or marketing costs;
• allocations of corporate overheads; or
• costs of changing the name of an entity.
For example, entity C is a dairy but also produces cheese. The cheese-making operations are being restructured. The equipment that is used in the cheese-making operations will be redesigned and staff will be trained to use the new equipment. To the extent that the restructuring relates to C's ongoing operations, a provision is not recognised for these costs. Therefore the costs of redesigning the operation and retraining staff are not included in the restructuring provision. Instead, costs of new equipment and costs of improvements to existing equipment should be capitalised when incurred
Changes in management structure
Fundamental re-organisations
Provide only when the actual action takes place except in case of resulting onerous contracts, if any (discussed later) - However these may indicate impairment of certain assets

22. Restructuring - example
A company provided at its last year end for a major restructuring of its operations. The only evidence at the prior year end of a commitment was a board decision to reorganise the operations. The reorganisation was completed in the current year
A company provided at its last year end for a major restructuring of its operations. The company had a detailed plan and had communicated this to its employees and customers. The reorganisation provision included 50,000 for the costs of relocation and retraining staff. The reorganisation was completed in the current year

23. Restructuring - example
A Board’s decision alone is not sufficient to indicate that there has been a past event and so no provision should be recognised in the prior period. The provision made in the previous year should be reversed as a prior year adjustment and the profit and loss account credited to exclude those costs, The full costs of reorganisation should be charged in he current year’s profit and loss account as they are incurred
The company can continue to recognise the provision in the prior year because it had an obligation from which it could not realistically withdraw, but will have to adjust it to exclude the 50,000 for relocation and retraining. These costs relate to the ongoing activities of the company and cannot be provided for under AS 29

24. Future Operating Losses
Provisions should not be recognised
However these indicate that certain assets may be impaired

25. Application – onerous contracts
Definition: contract under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent
BUT in which unavoidable estimated costs of meeting the obligation exceed the economic benefits expected to be received
Onerous present obligation under the contract should be recognised as a provision
Measurement at the lower of:
The fulfilment cost; and
Any compensation or penalties arising from failure to fulfil
If impairment losses on assets dedicated to the onerous contract have been recognised, provide for onerous obligation only if it is additionally required
An onerous contract is one in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under the contract.
A contract on unfavourable terms is not necessarily onerous. For example, entity B is the lessee of properties under operating leases. The lease payments on a number of the properties exceed normal market rentals for properties in the area. B does not have an onerous contract as long as the lease payments do not exceed the benefits it will derive from the properties
Similarly, a contract that is not performing as well as anticipated, or as well as possible, is not onerous unless the costs of fulfilling the obligations under the contract exceed the benefits to be derived.

26. Onerous contracts (B) NIL - 40 (A) 30 (A) 30 30 40
Variable Cost
Fixed cost
Total
Costs to fulfill contract 85 35
120
Revenue from contract 90
Unavoidable total cost of meeting the contract - 30
Penalty to terminate contract 40
(B) NIL - 40
(A) 30
(A) 30 30 40
Provision for onerous contract
(B) NIL
(A) 30
For determining unavoidable cost of meeting the contract, consider only direct variable cost. In this case it is lower at 85 against 90 of revenue. Hence no provision is required.
In our view, if a contract is for goods, or if an entity recognises and measures onerous service contracts under IAS 37, then only unavoidable costs directly associated with meeting the entity's obligations under the contract should be considered in determining whether the contract is onerous and in measuring any resulting provision. In our view, the unavoidable costs of meeting the obligations under the contract are only costs that:
• are directly variable with the contract and therefore incremental to the performance of the contract;
• do not include allocated or shared costs that will be incurred regardless of whether the entity fulfils the contract or not; and
• cannot be avoided by the entity's future actions.
In our view, costs that would be incurred regardless of whether the contract is fulfilled or not are not incremental. Costs that are not incremental include fixed and non-cancellable costs, such as depreciation of property, plant and equipment, non-cancellable operating lease costs, and personnel costs for employees who would be retained. Costs that are not incremental should not be considered in the onerous contract analysis as they are costs to operate the business. For example, entity Y provides data transmission services using a network infrastructure, which is purchased partly from external carriers. The network infrastructure lease contracts are non-cancellable and are on fixed payment terms regardless of the volume or number of customers serviced by Y using the network. For management purposes, Y uses a cost allocation methodology whereby the full cost of operating the network, including depreciation of owned equipment, rental of network infrastructure and personnel costs, is allocated to individual customer contracts. Y elected to recognise and measure onerous service contracts under IAS 37. In our view, depreciation of entity-owned equipment, rental of network infrastructure and personnel costs are fixed costs associated with operating the infrastructure and should not be included in the onerous contract analysis
In some cases, fulfilling an onerous contract may involve use of an item that is leased under a non-cancellable operating lease. Because the lease is not cancellable, the lease cost should not be considered an unavoidable cost of meeting the obligation under the onerous contract. In the example, Y needs to use the network equipment that is leased under a non-cancellable operating lease. While we believe that the lease cost should not be considered an unavoidable cost of meeting the obligation because this cost will be incurred whether or not the onerous contract exists, in our view, Y should consider whether its lease of the network equipment is itself an onerous contract.

27. Onerous contracts - examples
C manufactures chocolate and has a contract to buy cocoa beans at a cost of 7,800 per ton. The market price of cocoa beans has fallen to 7,000 per ton. Is the contract onerous?
The contract is not onerous unless the expected selling price of the final product (the chocolate) is less than the unavoidable cost of producing the chocolate

28. Onerous contracts - examples
V has a contract to purchase 1 million units of gas at 0.15 per unit, giving a contract price of 150,000. The current market price for a similar contract is 0.16 per unit, giving a price of 160,000. The gas will be used in generating electricity and the electricity will be sold at a profit
These circumstances do not indicate an onerous contract. The economic benefits from the contract include the benefits to the entity from using the gas in its business to produce electricity. The electricity is sold at a profit, therefore the contract is not onerous

29. Onerous contracts - examples
S, an airline has entered into an agreement under which it charters out an aircraft for 20 days for a fee of 10,000 per day. S incurs otherwise avoidable costs of 15,000 a day to operate the aircraft.
Extending the case, what would be the position, if S is able to cancel the charter arrangement by paying a penalty of 40,000?

30. Onerous contracts - examples
Cost of operating the aircraft exceeds revenues - contract is onerous
S should provide for the anticipated loss on the contract of 5,000 per day for the 20 days (i.e., 100,000 (5,000 x 20))
The lower of the cost of fulfilling the contract and of terminating the contract should be considered in measuring the provision, regardless of the entity's intention
If S is able to cancel the charter arrangement by paying a penalty of 40,000, a provision of 40,000 rather than 100,000 should be recognised, regardless of whether S intends to cancel the contract

31. Onerous contracts - examples
T is a tour operator. Among other services, T offers cruises on a lake. For this purpose, T leases a cruise ship under an operating lease. Due to increased competition for cruises, the costs of leasing the cruise ship exceed the income that T generates from its cruise operations. Assume that the operating lease contract relates only to T's cruise operations, and the cash flows relating to these operations are separately identifiable. Is the contract onerous?
What would be the position if T sold package tours, which included a cruise on the lake and T's overall operations were loss making?

32. Onerous contracts - examples
The lease contract should be treated as an onerous contract
If T sold package tours, which included a cruise on the lake, and T's overall operations were loss making, the losses would relate to the business as a whole rather than specifically to the lease contract
In addition, it is likely that the cash inflows relating to the cruise operations would not be clearly distinguished from those relating to the other operations. Therefore, in this case a provision for an onerous contract should not be recognised. However, T must consider if the related recognised assets are impaired

33. Onerous contracts - examples
L holds certain raw materials at the balance sheet date which are required as input for manufacturing a committed order whose sale price is even lower than the raw material cost. Whether any provision is required for the future loss?

34. Onerous contracts - examples
Contingent losses on firm sales contracts in excess of inventory quantities held are provided for if the losses are probable (AS 2)
Raw materials are valued at the lower of cost or market value. If cost is 100 and total estimated loss on the sale order is 40, the raw material would be valued at 60
If estimated loss on sale order was 110, the raw material would be valued at nil and a further provision of 10 would be required as per AS 29
If the estimated loss on the order to be executed was 50 and the raw material on hand 100 was good enough for manufacturing only 50% if the loss order, then a provision of 25 would be required on the raw material. Thus, raw material would be valued at 75. The balance loss of 25 would be recorded as a provision for onerous contract under AS 29

35. Disclosure - light is the best policeman!
For each class of provision
Brief description of nature of obligation and expected timing of outflows
Indication of uncertainties about those outflows (and major assumptions where required)
Amount of any expected reimbursement
(Not applicable to SMC and Level II/III non-corporate entities)

36. Disclosure – roll-forward by category
For each class of provision
Opening balances
+ additional provisions recognised (including increases to existing provisions)
- amounts used (i.e. incurred and charged against the provisions)
- unused amounts reversed
= ending balances
(Not applicable to SMC and Level II/III non-corporate entities)

37. Disclosure For each class of contingent liability disclosed
A brief description
Estimate of financial effects
Indication of uncertainties relating to any outflow
Possibility of any reimbursement
Where any of the above information is not disclosed because it is not practicable to do so, that fact should be stated

38. ‘Prejudicial to interest’ – exception to disclosure
Disclosure not required in the EXTREMELY RARE circumstances when disclosure would seriously prejudice the position of the entity in a dispute with another party
Disclose the general nature of the dispute and the fact that, and reason why, the information has not been disclosed
Due care needs to be exercised to ensure that exception is not misused to avoid disclosures

39. Differences with IAS 37 IAS 37 AS 29
Discounting
Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation
The Indian standard prohibits discounting
Contingent assets
Requires certain disclosures in respect of contingent assets
where an inflow of economic benefits is probable
Does not require or permit such disclosure. Contingent asset is usually disclosed in the report of the approving authority where an inflow of economic benefits is probable

40. Constructive obligation
Differences with IAS 37
IAS 37
AS 29
Constructive obligation
Provisions are required for both legal and constructive obligations
As per an appendix to the standard, it does not deal with constructive obligations