As we addressed here, 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 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). This seems likely to provide a much-enhanced basis for analyzing unfamiliar and complex fact patterns.

One of the most pored-over aspects of IAS 37 relates to recognizing restructuring costs. It currently states that a constructive obligation to restructure arises when an entity has a detailed formal plan for the restructuring and has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. But the basis for conclusions to the exposure draft points out:

• The IASB has become aware that inappropriate analogies are being drawn from these requirements because the wording implies that the public announcement of a restructuring plan is enough to meet the past-event condition and thus create a present obligation for restructuring costs. By analogizing to the requirements for restructuring provisions, stakeholders have sometimes concluded that an entity that has publicly announced a plan to change its operations in the future—for example, to reduce its annual greenhouse gas emissions in future years—has a present obligation for the future costs of changing its operations.

The IASB now concludes the standard shouldn’t refer to a constructive obligation to restructure because, among other things, “restructuring is an activity implemented for the benefit of the entity, not an obligation owed to another party. An entity does not have an obligation to restructure but rather might have obligations to discharge specific responsibilities if it restructures—for example, to pay redundancy costs to employees whose employment is terminated as part of the restructuring.” However, the existence of a formal plan, and the raising of a valid expectation among those affected by it, remains relevant in determining whether the entity’s obligation is a present one.

To illustrate, IAS 37 currently contains an example in which, on December 12, 20X0, the board of an entity decided to close a division; before the end of the reporting period (December 31, 20X0) the decision wasn’t communicated to any of those affected and no other steps were taken to implement the decision. The current standard curtly states that there has been no obligating event and so there is no obligation (this is in contrast to a situation where a detailed plan was agreed to before the end of the reporting period, letters were sent to customers warning them to seek an alternative source of supply, and redundancy notices were sent to the division’s staff). The exposure draft proposes clarifying the example by specifying that (under its new analytical approach) the obligation condition is met at December 31, for the following reason:

• The entity’s contracts with its employees impose a responsibility on the entity if it takes two actions—employing (obtaining services from) a person for at least a year and then terminating the employee’s contract. The entity owes that responsibility to its employees. The entity has no practical ability to avoid discharging its responsibility if it takes the two actions—closing the division will necessarily entail paying employee termination benefits.

The transfer condition is also met. Even so, the entity doesn’t recognize a provision, because the past-event condition isn’t met:

• The entity is required to pay employee termination benefits only if it takes two separate actions— employing (obtaining services from) a person for at least a year and then terminating the employee’s contract. At December 31, 20X0 the entity has taken the first action but still has the practical ability to avoid the second action because…the entity has not yet started to implement a closure plan or announced the main features of a closure plan to affected employees.

Again, this seems like a major improvement in clarifying the concepts underlying IAS 37 and relating them to the overall conceptual framework. The comment period on the exposure draft is open until March 12, 2025 – we’ll no doubt come back to it again.

The opinions expressed are solely those of the author.