The IASB has issued Provisions – Targeted Improvements, an exposure draft of proposed amendments to IAS 37.

You’ll recall that a provision is “a liability of uncertain timing or amount” and under IAS 37 in its current form is recognized when an entity has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. The main focus of the exposure draft is on that first criterion. The basis for conclusion sets out some of the underlying thinking:

• Paragraphs 17–22 of IAS 37 identify two conditions within the present obligation recognition criterion: (a) an obligation condition—there exists a mechanism, for example, a law or a policy the entity has published, that imposes responsibilities on the entity and leaves the entity with no realistic alternative to discharging those responsibilities if a specific event occurs; and (b) a past-event condition—the specific event has occurred and consequently the obligation is a present obligation.
• The obligation and past-event conditions are distinct—the obligation condition relates to the strength of the mechanism that requires the entity to settle a present obligation once it has arisen, whereas the past-event condition relates to the timing of the event that gives rise to the present obligation. However, although the obligation and past-event conditions are distinct, IAS 37 does not identify them separately. Instead, it combines them into a single requirement for an ‘obligating event’, which paragraph 10 in IAS 37 defines as ‘an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation’…
• Application problems arise because it can be unclear which condition an explanation refers to, so an explanation of one condition can appear to apply to the other condition. For example, paragraph 19 of IAS 37 refers to an entity having no present obligation if it can avoid future expenditure through its future actions. It is unclear whether this reference applies to actions the entity could take to avoid creating a present obligation (the past-event condition) or to actions it could take to avoid settling the obligation (the obligation condition).

Consequently, the exposure draft proposes setting out that the “present obligation” criterion comprises three conditions: an obligation condition (the entity has an obligation); a transfer condition (the nature of the entity’s obligation is to transfer an economic resource); and a past-event condition (the entity’s obligation is a present obligation that exists as a result of a past event). The upshot of this may be best illustrated, for our summarized purposes here, with reference to the standard’s illustrative examples, which in their long-standing current form are mostly very brief and somewhat cryptic. Take example 6, regarding an entity that under new legislation is required to fit smoke filters to its factories by June 30, 20X1 but hasn’t done so, and may therefore be subject to fines. IAS 37 currently sweeps away the accounting as at December 31, 20X0 with the single sentence: “There is no obligation because there is no obligating event either for the costs of fitting smoke filters or for fines under the legislation.”

The exposure draft in contrast proposes setting out the scenario more fully and analyzing the situation more systematically and fully with reference to the three conditions:

• The obligation condition is met: The legislation imposes responsibilities on the entity if it produces smoke after June 30, 20X1.The entity owes these responsibilities to the government, which acts on behalf of factory workers. The entity has no practical ability to avoid discharging its responsibilities if it produces smoke after June 30, 20X1.
• The transfer condition isn’t met for the smoke filters at that date: It is an obligation to exchange economic resources, not an obligation to transfer an economic resource. In buying and fitting the filters, the entity will pay cash and receive property, plant and equipment in exchange. However, the transfer condition is met for the fines: It is an obligation that has the potential to require the entity to pay cash.
• The past event condition also isn’t met at that date: The entity hasn’t yet taken the action (producing smoke subsequent to June 30, 20X1) as a consequence of which it will have to fit smoke filters or else pay the fines. Also, the entity hasn’t yet obtained the economic benefits (the smoke filters) as a consequence of which it will have to pay for the filters.

This seems at first glance to provide a much-enhanced basis for analyzing unfamiliar and complex fact patterns. The comment period on the exposure draft is open until March 12, 2025 – we’ll come back to it between now and then.

The opinions expressed are solely those of the author.