Amendments to IAS37 Provisions and to IAS19 Employee Benefits

Comments from ACCA
November 2005

ACCA is pleased to have this opportunity to comment on the above exposure draft (ED). The ED has been considered by ACCA’s Financial Reporting Committee.

General comments

Our overall view is that the IASB should not proceed to issue standards based on this ED. Our main reasons for this are as follows.

We agree that the current version of IAS37 has some inconsistencies and flaws in it among which are the matters covered by these EDs. We are not aware, however, that these constitute major flaws which are undermining the standing of financial reporting and the IASB’s standards. Given the recent adoption of the standards by so many enterprises in Europe and other jurisdictions, further changes in the standards must be justified by the better information conveyed to users or possibly the ease of preparation by reporting entities.

This ED makes some significant changes to the concepts which underpin the recognition of liabilities. The Basis for Conclusions sets out at some length why this ED is consistent with the IASB’s Framework (and therefore presumably why the current version of IAS37 is not). Whatever the merits of that argument, the ED introduces new concepts in order to show that it remains within the Framework. These are the concepts of the conditional element of a liability and the non-conditional element (particularly the stand-ready obligation). One way or another, this is a conceptual change which should have been dealt with in a discussion paper first before proceeding to an ED.

ACCA’s responses to the questions raised for comment by IASB

Our responses on the matters set out below have to be read in the context that we consider the proposals should not be put in place as the changes would bring insufficient improvement to justify them.

Q1. Scope of IAS37 and terminology

We agree that IAS37 should try to deal with those liabilities that are not covered by other standards including those on financial instruments. We are not convinced that non-financial liabilities is a very satisfactory term, as many of these liabilities will involve the outflow of cash in the future.

Q2. Contingent liabilities

This is the most significant proposal of the ED and would recognise and measure many liabilities that are currently not included in the balance sheet, those where the probability of an outflow was rated as less than 50%. In these cases there would instead be considerable disclosure of information in the notes to the financial statements. This is an approach which seems to be working without significant problems for the users of accounts.

In cases where the assessment of outcomes is very subjective it does not seem to add useful information simply to incorporate these very uncertain numbers in the balance sheet and profit and loss account rather than disclose comparable information in the notes. There may be some risk that the existing note disclosure explaining the contingent liabilities might be reduced in quality when the possible liability is provided for in the balance sheet.

As noted above the change represents a conceptual change which should be considered by a more extensive due process.

Q3. Contingent assets

The ED deals inadequately with this issue. It neither considers whether such assets are within the scope of IAS38 nor whether the accounting treatment in IAS38 would be appropriate. Many such assets derive from litigation or disputes over contracts. It is hard to see the common ground between these and intellectual property or licences that make up much of the items covered by IAS38. It seems equally possible that such items could better fall under IAS39. In terms of treatment IAS38 makes a significant difference between self-generated and purchased intangibles. We see little justification for this when it comes to the outcomes of litigation.

One of the main inconsistencies in the treatment of contingent assets has been that they could only be recognised when receipt was virtually certain, whereas other standards set a lower threshold for asset recognition of probable inflow of benefits. This inconsistency would be eliminated by these proposals.

Q4. Constructive obligations

We agree that these changes would be appropriate.

Q5. Probability recognition criterion

As noted in our answer to Q2 above we do not agree with this change for the present.

The existing recognition threshold provides a reasonable discriminator for providing full information about a liability, or not. The proposals would tend to require similar treatment for liabilities that are almost certain as for those with perhaps a very low probability of occurrence even if the potential payout is large.

The new recognition criteria are also in need of clarification as regards obligating events. Looking at Illustrative Examples 1 and 2 one might conclude there is an unconditional obligation for any disputed matter which has reached the courts or where the entity accepts there it has been negligent or done wrong. There is presumably no obligation before that point if the management believe that no wrong has been done. This seems a rather ‘bright line’ approach which might not be easy to translate to different contexts, for instance possible regulatory action.

Q6. Measurement

We do not consider that the basis of measurement in IAS37 is being altered fundamentally. The proposals seem reasonable clarification of the existing model.

Q7. Reimbursements