1. 1 International Financial Reporting Standards IFRS for SMEs IFRS Foundation-World Bank 18–20 October 2011 Sarajevo, Bosnia and Herzegovina Copyright © 2010 IFRS Foundation. All rights reserved.

2. 2 The IFRS for SMEs Topic 3.1(a) Section 21 Provisions and Contingencies Section 28 Employee Benefits Liam Coughlan

3. 3 The IFRS for SMEs Section 21 Provisions & Contingencies

4. 4 Section 21 – Scope Section 21 applies to accounting & reporting of provisions, contingent liabilities & contingent assets except those provisions covered by other sections including: –leases (Section 20). However, Section 21 covers onerous operating leases –construction contracts (Section 23) –employee benefit obligations (Sec. 28) –income tax (Section 29)

5. 5 Section 21 – Provisions Provisions are liabilities of uncertain timing or amount. A liability is a present obligation… A present obligation may be either –legal (binding contract or statutory requirement) –constructive (derives from an entitys actions which the entity has no realistic alternative to settling)

6. 6 Section 21 – Examples provisions Ex 1*: Waste from As factory contaminated the groundwater. Lawsuit: local community seek compensation for damages to health from contamination. A acknowledges wrongdoing. Court is deciding extent of the compensation. Lawyers expect ruling in +2 yrs & compensation in the range of CU1,000,000 to CU30,000,000. * see example 1 in Module 21 of the IFRS Foundation training material

7. 7 Section 21 – Examples provisions continued Ex 2*: Waste from As factory contaminated the groundwater. Required by law to restore the environment. Estimates restoration cost between 1,000,000 & 15,000,000. Unsure of period to complete restoration. Ex 3*: A manufacturer gives warranties to the purchasers of its goods. Warranty = make good, by repair or replacement, manufacturing defects that become apparent within 3 years of sale. *see example with the same number in Module 21 of the IFRS Foundation training material

8. 8 Section 21 – Examples not provisions Ex 4*: provision for self-insurance Ex 5*: Ski-resort operator operates in a very cyclical business, with good years and bad years depending primarily on the weather. To reduce earnings volatility, it recognises provisions in good years to reverse in bad years. Ex a: provision for depreciation Ex b: provision for doubtful debts * see example with the same number in Module 21 of the IFRS Foundation training material

9. 9 Section 21 – Example constructive oblig. Ex 12*: Waste from As factory contaminated the groundwater. A is not required by law to restore the contaminated environment & there is no court case. However, in the reporting period the entity publicly announced that it would restore the contaminated environment within the next 12 months. * see example 12 in Module 21 of the IFRS Foundation training material

10. 10 Section 21 – Recognition of provisions Recognise a provision when: –the entity has an obligation at the reporting date as a result of a past event; –it is probable (ie more likely than not) that the entity will be required to transfer economic benefits in settlement; & –the amount of the obligation can be estimated reliably. Use of estimates is essential part of preparing financial statements and does not undermine their reliability.

11. 11 Section 21 – Measurement of provisions Measure provision at best estimate of the amount required to settle the obligation at the reporting date = 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 & adjust them to reflect the current best estimate at that reporting date. –unwinding of the discount is a finance cost

12. 12 Section 21 – Best estimate If large population of items, best estimate reflects probability weighting of all possible outcomes. If single obligation, best estimate = 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).

13. 13 Section 21 – Examples measurement Ex 14*: 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) * see example 14 in Module 21 of the IFRS Foundation training material

14. 14 Section 21 – Examples measurement Ex 15*: 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 * see example 15 in Module 21 of the IFRS Foundation training material

15. 15 Section 21 – Example remeasurement Ex 25*: 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 entitys profit or loss for the year ended 31/12/20X2 –CU3,000 = finance cost –CU47,000 = change in estimate * see example 25 in Module 21 of the IFRS Foundation training material

16. 16 Section 21 – Provision disclosure For each class of provision, no comparatives –a reconciliation showing –CA opening & closing –additions, incl. measurement adjustments –charged against provision in period –unused amounts reversed in period –nature, expected payments (amount & timing) –indication of uncertainties (amount or timing) –amount of any expected reimbursement & amount recognised as an asset

17. 17 Section 21 – contingent liabilities A contingent liability is either: (i) a possible but uncertain obligation; or (ii) a present obligation that is not recognised because it fails the recognition criteria in paragraph 21.4.

18. 18 Section 21 – Contingent liabilities Do not recognise a contingent liability as a liability (except contingent liabilities of an acquiree in a business combination). Contingent liabilities are disclosed unless the possibility of an outflow of resources is remote. When an entity 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.

19. 19 Section 21 – Example contingent liability Ex 29*: Community is seeking compensation from A for damages to their health as a result of contamination believed to be caused by As plant. It is doubtful whether A is the source of the contamination because –many entities operate in the same area producing similar waste & it is unclear which entity is the source of the leak –A has taken precautions to avoid leaks & is vigorously defending the case. * see example 29 in Module 21 of the IFRS Foundation training material

20. 20 Section 21 – Example contingent liability Ex 29 continued : However, it is not certain that it did not caused the leak & the true offender will only become known after extensive testing has been performed. As legal counsel expects a court ruling in approximately 2 years. If A loses the case, compensation is likely to be in the range of CU1,000,000 to CU30,000,000.

21. 21 Section 21 – Example contingent liability Ex 29 continued : It may be uncertain whether the entity has a present obligationthis is the matter being determined by the court. –if taking account of all of the available evidence, it is probable that the entity will successfully defend the court case then the entity has a possible obligation & hence a contingent liability.

22. 22 Section 21 – Contingent liab disclosure For each class of contingent liability unless the possibility of any outflow is remote, disclose, a brief description of the nature of the contingent liability and, when practicable: –estimate of its financial effect (measured like a provision); –indication of uncertainties of amount or timing; & –possibility of any reimbursement. If impracticable to make one or more of these disclosures, that fact shall be stated.

23. 23 Section 21 – Contingent asset Do not recognise a contingent asset as an asset. Disclose a contingent asset when an inflow of economic benefits is probable. However, when the flow is virtually certain, then the related asset is not a contingent asset, and its recognition is appropriate.

24. 24 Section 21 – Contingent asset disclosure If an inflow of economic benefits is probable (more likely than not) but not virtually certain, disclose: –a description of the nature of the contingent assets at the end of the reporting period, and –when practicable without undue cost or effort, an estimate of their financial effect (measured using the principles set out for measuring provisions). If it is impracticable to make this disclosure, that fact shall be stated.

25. 25 Section 21 – Prejudicial disclosures In extremely rare cases, disclosure of some or all of the information required by paras 21.14–21.16 can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the provision, C liab. or C asset. In such cases, need not disclose the information, but must disclose the general nature of the dispute, together with the fact that, & reason why, the information has not been disclosed. Note: no recognition & measurement exemption for provisions.

26. 26 The IFRS for SMEs Section 28 Employee Benefits

27. 27 Section 28 – Scope Employee benefits (EBs) are all forms of consideration given by an entity in exchange for service rendered by employees, including directors and management. Section 28 applies to all EBs, except for share-based payment transactions, which are covered by Section 26 Share-based Payment.

28. 28 Section 28 – Types of employee benefits 4 types of EBs: –short-term employee benefits –post-employment benefits –other long-term employee benefits –termination benefits And equity compensation (see Section 26)

29. 29 Section 28 – General recognition criteria Recognise cost of EBs to which employees have become entitled for service rendered to entity in reporting period –liability, after deducting amounts that have been paid. Asset if prepaid EB expense –expense, unless another section requires cost included in asset (for example inventories or PP&E)

30. 30 Section 28 – Short-term employee benefits Short-term employee benefits (S/TEBs) are wholly due within 12 months after the end of the period in which the employees render the related service (hereafter 12 month limitation). –but excludes termination benefits.

31. 31 Section 28 – Short-term employee benefits Examples of S/TEBs include: –wages, salaries & social security contrib; –S/T compensated absences (paid annual leave & paid sick leave) for absences expected to occur within 12 month limitation; –profit-sharing & bonuses payable within 12 month limitation; & –non-monetary benefits (such as medical care, housing, cars and free or subsidised goods or services) for current employees.

32. 32 Section 28 – Measurement of S/TEBs Measure S/TEBs that meet general recognition criteria (above) –at the undiscounted amount expected to be paid

33. 33 Section 28 – Examples S/TEBs Ex 10*: 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. * see example 10 in Module 28 of the IFRS Foundation training material

34. 34 Section 28 – Examples S/TEBs Ex 13*: Same as Ex 10 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 10a: Similar to Ex 10 and Ex 13 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. * see example 13 in Module 28 of the IFRS Foundation training material

35. 35 Section 28 – Examples S/TEBs Ex 17*: A pays 3% of years 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%) * see example 17 in Module 28 of the IFRS Foundation training material

36. 36 Section 28 – Post-employment benefits Post-employment benefits (PEBs) are employee benefits (other than termination benefits) that are payable after the completion of employment Examples of PEBs include –retirement benefits, such as pension –other PEBs, such as post-employment life insurance and post employment medical care

37. 37 Section 28 – Post-employment benefits Arrangements whereby an entity provides PEBs are PEB plans. 2 types of PEB plans: –defined contribution plans (entity pays fixed contributions into a separate entity (a fund) and has no further obligations, ie all risks with employee). –defined benefit plans (actuarial & investment risk (if funded) with entity).

38. 38 Section 28 – PEBs defined contribution Recognise the contribution payable for a period as an expense, unless another section requires the cost to be recognised as part of the cost of an asset (eg inventories or PP&E). Ex 18*: On 8/1/20X2 a retailer paid 100 contribution to a defined contribution plan in part exchange for services performed by the entitys employees in December 20X1. At 31/12/20X1 recognise CU100 liability (accrual of PEBs) & CU100 expense in profit or loss. * modified from example 18 in Module 28 of the IFRS Foundation training material

39. 39 Section 28 – PEBs defined benefit plans Apply general recognition principle, recognise: –a liability for its obligations under defined benefit plans net of plan assetsitsdefined benefit liability (see paragraphs 28.15–28.23). –the net change in that liability during the period as the cost of its defined benefit plans during the period (see paragraphs 28.24–28.27).

40. 40 Section 28 – Defined benefit liability Measure defined benefit liability at net of: –PV of defined benefit obligation (DBO) –FV of plan assets (if any) out of which the obligations are to be settled directly –paragraphs 11.27–11.32 provide guidance on fair value measurement). If PV of DBO < FV of plan assets, plan has a surplus. Recognise surplus as asset only to extent recoverable through reduced future contributions or through refunds from the plan.

41. 41 Section 28 – Defined benefit obligation (DBO) PV of DBO reflects estimated amount of benefit that employees have earned in return for their service in the current & prior periods –including benefits that are not yet vested –including the effects of benefit formulas that give employees greater benefits for later years of service (eg final salary). Significant judgements in measuring DBO include actuarial assumptions.

42. 42 Section 28 – DBO actuarial assumptions Actuarial assumptions comprise: –demographic assumptions, eg: (i) mortality during & after employment; (ii) employee turnover, disability & early retirement; (iii) proportion of plan members with dependants who will be eligible for benefits; & (iv) claim rates under medical plans; –financial assumptions, eg: (i) discount rate; (ii) future salary & benefit levels; (iii) for medical benefitsfuture medical costs, including cost of administering claims and benefit payments.

43. 43 Section 28 – DBO valuation method Measure DBO using projected unit credit method (PUC). However, if undue cost or effort use simplified calculation. Under simplified calculation: –ignore estimated future salary increases; –ignore future service of current employees (ie assume closure of the plan for existing as well as any new employees); & –ignore possible in-service mortality of current employees (however, consider mortality after service (ie life expectancy)).

44. 44 Section 28 – DBO PUC valuation method Ex 30*: Lump sum benefit payable on retirement = 1% of final salary for each year of service. Salary in Y1 = 10,000 (increase at 7% pa). Discount rate = 10% pa. Employee expected to retire at end of Y5. Shows how the obligation builds up: –assuming that there are no changes in actuarial assumptions. –for simplicity, this example assumes employee will stay until end of Y5. * see example 30 in Module 28 of the IFRS Foundation training material

45. 45 Section 28 – DBO PUC valuation method Year12345 Attributed to: – prior years -131262393524 – current year (1% of final salary) 131 – current and prior years 131262393524655 Opening obligation -89196324476 Interest at 10% -9203348 Current service cost 8998108119131 Closing obligation 89196324476655

46. 46 Section 28 – DBO PUC valuation method Notes on PUC calculations: Current service cost is the present value of benefit attributed to the current year eg Y1 CU131 × 1/(1.1) 4 = CU131 ÷ 0.683013 = CU89.47 The closing obligation is the present value of benefit attributed to current and prior years.

47. 47 Section 28 – DBO simplified method Ex 33*: Same as Ex 30, except use simplified method of calculation. * see example 33 in Module 28 of the IFRS Foundation training material

48. 48 Section 28 – DBO simplified method Year 12345 1% of current salary (increase at 7% per year) 100107114123131 Years service at end of year 12345 FV of obligation 100214343490655 Discount factor (10%) 0.68300.75130.82640.90911 PV of obligation 68161284445655 Opening obligation –68161284445 Interest (10%) –7162845 Current service cost 688095111131 Actuarial gain or loss (balancing figure) –5122234 Closing obligation 68161284445655

49. 49 Section 28 – DBO simplified method Notes on simplified method calculations Current service cost = PV of benefit attributed to the current year –Calculation Y1: CU100 salary × 1/(1.1) 4 = CU68.30 Closing obligation = PV of benefit attributed to current & prior years –Calculation Y1: CU100 × 1 years service ÷ 1/(1.1) 4 = CU68.30

50. 50 Section 28 – Defined benefit expense Recognise net change in defined benefit liability in the period (other than benefits paid to employees or contributions from the employer) as the cost of its defined benefit plans during the period. Recognise cost either (accounting policy) –entirely in profit or loss as an expense, or –partly in profit or loss & partly as an item of OCI (only actuarial gains & losses can be in OCI) unless part of the cost of an asset (eg see Section 17 PP&E).

51. 51 Section 28 – Defined benefit expense Ex Ex 39*: A recognises actuarial gains & losses in profit or loss. Employees promised a pension of 0.2% of final salary for each year of service. The pension is payable from the age of 65. The plan is unfunded. At 31/12/20X1 CA of the plan obligation = CU1,000 (20X0: CU900). In 20X1 A paid pensions of CU40 to its past employees. * see example 39 in Module 28 of the IFRS Foundation training material

52. 52 Section 28 – Defined benefit expense Ex Defined benefit plan obligation (liability) account 1/1/20X1 Opening balance 900 20X1 Pension paid 40 31/12/20X1 Closing balance 1,00020X1 Profit or loss 140 1,040 1/1/20X2 Opening balance 1,000

53. 53 Section 28 – Defined benefit expense Ex Ex 42*: Same as Ex 39 except recognises all actuarial gains & losses in OCI. CU50 of the cost of the defined benefit plan for 20X1 is attributable to actuarial losses. Recognise CU140 expense for 20X1 as follows: –CU50 in OCI (ie actuarial gains & losses) –CU90 (the remainder) in profit or loss. * see example 42 in Module 28 of the IFRS Foundation training material

54. 54 Section 28 – Defined benefit expense Ex Ex 40*: Same as Ex 39 except plan is funded –in 20X1 fund paid pensions of CU40 to past employees & entity contributed CU110 to the fund. –at 31/12/20X1 FV of plan assets = CU980 (20X0: CU890). * see example 40 in Module 28 of the IFRS Foundation training material

55. 55 Section 28 – Defined benefit expense Ex Funded defined benefit plan (liability) account 1/1/20X1 Opening balance 10 (a) 20X1 Increase funding 110 31/12/20X1 Closing balance 20 (b) 20X1 Profit or loss 120 (c) 130 1/1/20X2 Opening balance 20 (a) CU900 obligation less CU890 plan assets (b) CU1,000 obligation less CU980 plan assets (c) balancing figure

56. 56 Section 28 – Other long-term employee benefits Other long-term employee benefits (OL/TEBs) are employee benefits (other than post-employment benefits & termination benefits) that are not wholly due within 12 months after the end of the period in which the employees render the related service.

57. 57 Section 28 – OL/TEBs Examples of OL/TEBs include: –long-term compensated absences, eg long-service or sabbatical leave –long-service benefits –long-term disability benefits –profit-sharing & bonuses payable + 12 months after the end of the period in which the employees render the related service –deferred compensation paid + 12 months after the end of the period in which it is earned

58. 58 Section 28 – OL/TEBs Recognise a liability for OL/TEBs measured at the net of: –PV of the benefit obligation –FV of plan assets (if any) out of which the obligations are to be settled directly. Expense recognition is same as post- employment defined benefit plan –can choose to recognise actuarial gains & losses in OCI)

59. 59 Section 28 – Termination benefits Termination benefits are employee benefits payable as a result of either: –an entitys decision to terminate an employees employment before the normal retirement date, or –an employees decision to accept voluntary redundancy in exchange for those benefits.

60. 60 Section 28 – Termination benefits Termination benefits include commitments by legislation, by contractual or other agreements with employees or their representatives or by a constructive obligation based on business practice, custom or a desire to act equitably, to make payments (or provide other benefits) to employees when it terminates their employment.

61. 61 Section 28 – Recognition & measurement Recognise termination benefits as a liability & an expense only when the entity is demonstrably committed either: –to terminate the employment of an employee before the normal retirement date, or –to provide termination benefits as a result of a firm voluntary redundancy offer. measure at best estimate of expenditure that would be required to settle the obligation at reporting date (PV if > 12 months).

62. 62 Section 28 – EBs disclosures PEBs have extensive disclosures. S/TEBs Section 28 does not specify disclosures For each category OL/TEBs & termination benefits: the nature of the benefit, the amount of its obligation and the extent of funding at the reporting date.

63. © 2010 IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org 63 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.

64. 64 This presentation may be modified from time to time. The latest version may be downloaded from: http://www.ifrs.org/Conferences+and+Workshops/IFRS+for+SMEs+Train+ the+trainer+workshops.htm The accounting requirements applicable to small and medium sized entities (SMEs) are set out in the International Financial Reporting Standard (IFRS) for SMEs, which was issued by the IASB in July 2009. 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.