Closure of a division – Example on recognising and measuring provisions
Just to provide the right frame for the case here is a short introduction of the key features of IAS 37 needed to judge the court case.
Key definitions [IAS 37 10] Closure of a division
Provision – a liability of uncertain timing or amount. Closure of a division
Liability Closure of a division
- present obligation as a result of past events Closure of a division
- settlement is expected to result in an outflow of resources (payment) Closure of a division
Contingent liability Closure of a division
- a possible obligation depending on whether some uncertain future event occurs, or Closure of a division
- a present obligation but payment is not probable or the amount cannot be measured reliably Closure of a division
Recognition of a provision Closure of a division
An entity must recognise a provision if, and only if: [IAS 37 14]
- a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event),
- payment is probable (‘more likely than not’), and Closure of a division
- the amount can be estimated reliably. Closure of a division
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37 10]
A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for example, a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period. [IAS 37 10] Closure of a division
A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote. [IAS 37 86]
In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present obligation. In those cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date. A provision should be recognised for that present obligation if the other recognition criteria described above are met. If it is more likely than not that no present obligation exists, the entity should disclose a contingent liability, unless the possibility of an outflow of resources is remote. [IAS 37 15]
On 12 December 20X0 the board of an entity decided to close a division making a particular product. On 20 December 20X0 a detailed plan for closing the division was agreed by the board, letters were sent to customers warning them to seek an alternative source of supply, and redundancy notices were sent to the staff of the division.
Present obligation as a result of a past obligating event—the obligating event is the communication of the decision to the customers and employees, which gives rise to a constructive obligation from that date, because it creates a valid expectation that the division will be closed.
An outflow of resources embodying economic benefits in settlement—probable.
Conclusion—the entity recognises a provision at 31 December 20X0 for the best estimate of the costs that would be incurred to close the division at the reporting date.
On 12 December 20X0 the board of an entity decided to close down a division. Before the end of the reporting period (31 December 20X0) the decision was not communicated to any of those affected and no other steps were taken to implement the decision.
Present obligation as a result of a past obligating event—there has been no obligating event, and so there is no obligation.
Conclusion—the entity does not recognise a provision.
All of the entities in the examples have 31 December as their reporting date. In all cases, it is assumed that a reliable estimate can be made of any outflows expected. In some examples the circumstances described may have resulted in impairment of the assets; this aspect is not dealt with in the examples. References to ‘best estimate’ are to the present value amount, when the effect of the time value of money is material.
See also: The IFRS Foundation