Existence uncertainty is uncertainty about whether an asset or a liability exists.
There are sections in IFRS that discuss cases in which it is uncertain whether an asset or liability exists. In some cases, that uncertainty, possibly combined with a low probability of inflows or outflows of economic benefits and an exceptionally wide range of possible outcomes, may mean that the recognition of an asset or liability, necessarily measured at a single amount, would not provide relevant information. Whether or not the asset or liability is recognised, explanatory information about the uncertainties associated with it may need to be provided in the financial statements.
If the probability of an inflow or outflow of economic benefits is low, the most relevant information about the asset or liability may be information about the magnitude of the possible inflows or outflows, their possible timing and the factors affecting the probability of their occurrence. The typical location for such information is in the notes.
Even if the probability of an inflow or outflow of economic benefits is low, recognition of the asset or liability may provide relevant information beyond the information provided in the notes described in the above paragraph. Whether that is the case may depend on a variety of factors. For example:
- if an asset is acquired or a liability is incurred in an exchange transaction on market terms, its cost generally reflects the probability of an inflow or outflow of economic benefits. Thus, that cost may be relevant information, and is generally readily available. Furthermore, not recognising the asset or liability would result in the recognition of expenses or income at the time of the exchange, which might not be a faithful representation of the transaction.
- if an asset or liability arises from an event that is not an exchange transaction, recognition of the asset or liability typically results in recognition of income or expenses. If there is only a low probability that the asset or liability will result in an inflow or outflow of economic benefits, users of financial statements might not regard the recognition of the asset and income, or the liability and expenses, as providing relevant information.
In some cases, the level of uncertainty involved in estimating a measure of an asset or liability may be so high that it may be questionable whether the estimate would provide a sufficiently faithful representation of that asset or liability and of any resulting income, expenses or changes in equity. The level of measurement uncertainty may be so high if, for example, the only way of estimating that measure of the asset or liability is by using cash-flow-based measurement techniques and, in addition, one or more of the following circumstances exists:
- the range of possible outcomes is exceptionally wide and the probability of each outcome is exceptionally difficult to estimate.
- the measure is exceptionally sensitive to small changes in estimates of the probability of different outcomes—for example, if the probability of future cash inflows or outflows occurring is exceptionally low, but the magnitude of those cash inflows or outflows will be exceptionally high if they occur.
- measuring the asset or liability requires exceptionally difficult or exceptionally subjective allocations of cash flows that do not relate solely to the asset or liability being measured.
In some of the cases described above in the previous paragraph, the most useful information may be the measure that relies on the highly uncertain estimate, accompanied by a description of the estimate and an explanation of the uncertainties that affect it. This is especially likely to be the case if that measure is the most relevant measure of the asset or liability. In other cases, if that information would not provide a sufficiently faithful representation of the asset or liability and of any resulting income, expenses or changes in equity, the most useful information may be a different measure (accompanied by any necessary descriptions and explanations) that is slightly less relevant but is subject to lower measurement uncertainty.
In limited circumstances, all relevant measures of an asset or liability that are available (or can be obtained) may be subject to such high measurement uncertainty that none would provide useful information about the asset or liability (and any resulting income, expenses or changes in equity), even if the measure were accompanied by a description of the estimates made in producing it and an explanation of the uncertainties that affect those estimates. In those limited circumstances, the asset or liability would not be recognised.
Whether or not an asset or liability is recognised, a faithful representation of the asset or liability may need to include explanatory information about the uncertainties associated with the asset or liability’s existence or measurement, or with its outcome—the amount or timing of any inflow or outflow of economic benefits that will ultimately result from it.
- financial statement preparers to estimate the future outcome of the uncertainties inherent in many business transactions, Existence uncertainty
- auditors to verify the subjective judgements about those uncertainties, and Existence uncertainty
- investors to understand those uncertainties and assess their potential impact on future earnings or cash flows. Existence uncertainty
For example, seemingly small changes from a management-selected input used to determine fair value could have a material impact on the reported result at any specific date. For example, when a fair value measure is determined primarily based on a discounted cash flow analysis, use of a discount rate that is 100 basis points different could mean the difference between a material goodwill impairment charge, or none at all.
Generally accepted accounting standards provide processes by which uncertainty is factored into financial statements. Accountants recognize some uncertainties as inherent in certain financial transactions. The challenge is to recognize uncertainty and apply the information in ways that reflect a more realistic financial picture of a company. Existence uncertainty
- Measurement and recognition — whether measurements that involve uncertainty provide investors with useful information.
- Disclosure — the information that investors find important to understand and assess measurement uncertainties and the challenges or impediments that preparers face in providing that information. Existence uncertainty
Certain recent accounting standards have potentially increased the extent of measurement uncertainty in financial statements (for example the fair value option in IFRS 9) and some standards have attempted to increase the transparency into the measurement uncertainty that underlies financial statement items (for example IFRS 13 Fair value measurement). Nonetheless, there continue to be questions about the recognition and measurement of uncertainty; the disclosures necessary to understand the measurement uncertainty; and how uncertainty impacts auditability. Existence uncertainty
The IFRS Conceptual Framework for Financial Reporting states, “if the level of uncertainty … is sufficiently large, that estimate will not be particularly useful.” The nature and extent of measurement uncertainty depend on the economic phenomena that the underlying financial statement item is intended to represent. Some question what is the right balance and whether sufficient information is provided to understand the nature and extent of measurement uncertainty. Existence uncertainty
To explore this topic, it may be useful to illustrate some of the various accounting treatments that currently incorporate uncertainty. For example,
- Certain illiquid financial assets reflected at estimated fair value are adjusted up or down for changes in the estimated fair value; however, non-financial assets (e.g., goodwill) are only adjusted down when the recorded amount is greater than the fair value at a point in time.
- Contingent liabilities are recognized when it is probable that a loss has been incurred and can be reasonably estimated and are measured as a single point estimate. If the single point estimate is within a range, the additional maximum exposure to loss is required to be disclosed.
- Certain guarantees are measured based on probability-weighted expected future outcomes. Existence uncertainty
- The financial statement effects of uncertain tax positions are recognized when it is more likely than not, based on the technical merits, that the positions will be sustained upon examination and are measured as the largest amount that has more than a 50% chance of being realized.
- Certain illiquid financial assets are measured at present value based on discounted future cash flows regardless of the certainty of those cash flows. Existence uncertainty
- Acquired identifiable intangibles are recognized without regard to measurement uncertainty. However, most internally developed intangibles (e.g., research and development and goodwill) are never recognized in the financial statements because the future benefits are deemed to be too uncertain. Existence uncertainty
- When there is substantial doubt about an entity’s ability to continue as a going concern, the financial statements are generally not adjusted to reflect the uncertainty. Instead, disclosures are provided and include, among other things, information about the uncertainty, the recoverability and classification of recorded asset amounts, and the amounts or classification of liabilities.
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