As we addressed here, IFRIC recently considered a fact pattern involving 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.
In its tentative agenda decision (“TAD” as the acronym has it) IFRIC tentatively concluded that an entity that has produced or imported vehicles with average fuel emissions higher than the government target has a present obligation that meets the definition of a liability in IAS 37, unless accepting the sanctions that the government can impose is a realistic alternative to eliminating negative credits for that entity. The analysis in part was that 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 that exception applies.
A few commenters, while not necessarily disagreeing with the overall conclusion, took issue with aspects of the technical analysis, identifying areas of possible inconsistency with current practice. PricewaterhouseCoopers among others focused on a current illustrative example to IAS 37, addressing an entity that under new legislation is required to fit smoke filters to its kitchens by (say) January 1, 2023; IAS 37 currently indicates that there is no obligating event before that date. PWC pointed out though that the fact pattern could easily be tweaked so that the present obligation appears to arise in 2021 rather than 2023 (even if the corrective actions needn’t be carried out until later). For this and other reasons, they concluded: “we are concerned that the technical analysis in this TAD can be interpreted as placing emphasis on the form of the legislation rather than the substance of the legislation…which could result in scenarios that are economically equivalent being accounted for differently…”
Related considerations led to EY not supporting IFRIC’s conclusion:
- We believe that the TAD should conclude that an entity that has produced or imported vehicles with average fuel emissions higher than the government target does not immediately have a legal obligation that meets the definition of a liability in IAS 37… In the fact pattern presented in the submission to the Committee, the entity can exit the market without the government being able to pursue it for the deficit created by its past sales and imports, i.e., the government has no legally enforceable right at the reporting date.
Among other issues arising, Deloitte commented that “the term ‘sanction’ can have different meaning in different jurisdictions and, depending on facts and circumstances, sanctions may represent an alternative means of imposing a penalty upon an entity as part of the enforcement of the law. Accordingly, we believe that the TAD should avoid implying that an obligation cannot be enforced by law whenever accepting sanctions is a realistic alternative for an entity. Instead, we suggest that the TAD should highlight that if accepting sanctions represents a realistic alternative, an entity would consider whether this realistic alternative indicates that the obligation cannot be enforced by law, such that the entity does not have a legal obligation (in which case, as indicated in the TAD, the entity would assess whether it has a constructive obligation)…” And numerous respondents pointed to issues beyond the scope of the current agenda decision. For instance, New Zealand’s External Reporting Board acknowledged that the decision “focuses only on meeting the definition of a liability – rather than on the measurement of such liabilities or on assets arising from emission reduction schemes. However…the measurement of liabilities relating to emission reduction programmes can be challenging, and…there is need for a broader standard-setting project on accounting for matters relating to emission trading schemes, as there is currently limited guidance in IFRS Standards on such matters.”
It seems likely, based on all that, that IFRIC will stick with its basic conclusion, but with some fine-tuning of the underlying analysis. Hey, that’s why those TADs are tentative!
The opinions expressed are solely those of the author