Here’s a summary of a request recently received by the IFRIC:

• The request described government measures that apply to entities that produce or import passenger vehicles for sale in a specified market. Under the measures, entities receive positive credits if in a calendar year they have produced or imported vehicles whose average fuel emissions are lower than a government target, and negative credits if in that year they have produced or imported vehicles whose average fuel emissions are higher than the target.
• The measures require an entity that receives negative credits for one year to eliminate those negative credits, either by purchasing positive credits from another entity or by generating positive credits itself in the next year (by producing or importing more low emission vehicles) and using those positive credits to eliminate the negative balance. If the entity fails to eliminate its negative credits in one or other of those two ways, the government can impose sanctions on the entity, for example restrict the entity’s access to the market.
• The request considered the position of an entity that has produced or imported vehicles with average fuel emissions higher than the government target, and asked whether such an entity has a present obligation that meets the definition of a liability in IAS 37.

The submission to the IFRIC set out the possibility of concluding that the entity has no such present obligation, because it can avoid the future expenditure by its future actions, for example by submitting a remedial plan or even by exiting the market. The submission argued: “While these alternatives may not be economical, that does not mean they are unrealistic. According to IAS 37.19, only those obligations arising from past events existing independently of an entity’s future actions (i.e., the future conduct of its business) should be recognized as provisions.”

IFRIC tentatively concluded though that the entity does indeed have such a liability, unless accepting the sanctions that the government can impose is a realistic alternative to eliminating negative credits for that entity. To the extent that an entity has produced or imported vehicles with average fuel emissions higher than the government target by the end of the reporting period, that obligation has arisen from past events. The obligation is a legal obligation and the sanctions the government can impose are the means by which settlement can be enforced by law; therefore the requirement that ‘settlement of the obligation can be enforced by law’ is met, unless accepting sanctions for non-settlement is a realistic alternative for an entity. An entity can settle its obligation either by purchasing positive credits from another entity or by generating positive credits itself in the next year and using those positive credits to eliminate the negative balance: in either case, settlement involves an outflow from the entity of resources embodying economic benefits.

Regarding the argument set out above, the underlying staff paper observes among other things that although adopting a remedial plan—or even exiting the market—might be an option in theory, for many entities it is not a realistic option in practice: “Changing production or import schedules is costly and might not be achievable within one year, as evidenced by the fact that many entities have instead established a practice of purchasing positive new energy credits in the market.” The paper also notes that adopting a remedial plan is not an option for avoiding the entity’s obligation, rather, it is a means of settling that obligation, also in one way or another entailing an outflow of economic benefits.

The committee also considered a case where an entity has produced or imported vehicles with average fuel emissions higher than the government target; but doesn’t have a legal obligation that meets the definition of a liability in IAS 37, because accepting sanctions is a realistic alternative for that entity, meaning the obligation cannot be enforced by law. It concluded that such an entity nevertheless could have a constructive obligation that meets the definition of a liability in IAS 37 if it has taken an action (for example, it’s made a sufficiently specific current statement) that has created valid expectations in other parties that it will eliminate negative credits generated from its past production or import activities.

Overall, the Committee concluded that the issue can be adequately analyzed with reference to existing standards, and tentatively decided not to add a standard-setting project to the work plan. The deadline for commenting on the tentative agenda decision is April 12, 2022. While the framework of IAS 37 is famously unsatisfactory in various ways, it’s hard to think that the information content of the financial statements for the entity described would be in any way enhanced by not recognizing a liability, whatever the technical aspects of the argument…

The opinions expressed are solely those of the author