Obligating event

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

A legal obligation is an obligation that derives from:

  1. a contract (through its explicit or implicit terms);
  2. legislation; or
  3. other operation of law.

A constructive obligation is an obligation that derives from an entity’s actions where:

  1. by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and
  2. as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

A term often used to describe an obligation that arises when an entity has no practical ability to act in a manner that is inconsistent with its customary practices, or published policies or specific statements, that require the transfer of an economic resource.

Past event means that the reporting entity has received the economic benefits, or conducted the activities, that establish the extent of the reporting entity’s obligation. So one part of the transaction (the reporting entity has received the economic benefits) has been effectuated, the return of a transfer of other economic benefits (cash) has not been effectuated yet.

Present obligation to transfer an economic resource – An obligation of an entity to transfer an economic resource:

  1. for which the entity has no practical ability to avoid the transfer; and
  2. that has arisen from past events; in other words, the entity has received the economic benefits, or conducted the activities, that establish the extent of its obligation.
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The obligation is discharged by the third party business entity by the transfer of  (other) economic benefits by the reporting entity.

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A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the case only:

  1. where the settlement of the obligation can be enforced by law; or
  2. in the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation. [IAS 37 17]

Financial statements deal with the financial position of an entity at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an entity’s statement of financial position are those that exist at the end of the reporting period. [IAS 37 18]

In contrast, a contingent liability is either a:

  • possible obligation arising from past events whose existence will be confirmed only by the occurrence or non-occurrence of some uncertain future event not wholly within the entity’s control, or
  • present obligation that arises from a past event but is not recognized because either:
    1. it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or
    2. the amount of the obligation cannot be measured with sufficient reliability.
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Specific applications

No provision should be made for future operating losses, including those relating to a restructuring, as they do not meet the definition of a liability at the end of the financial reporting period. Provisions should be made for onerous contracts, being contracts where the unavoidable future costs under the contract exceed the expected future economic benefits (e.g. a leased property sub-let at a lower rent).
A restructuring is a sale or termination of a line of business, closure of business locations, changes in management structure or a fundamental re-organisation of the company.

No obligation arises for the sale of an operation until there is a binding sale agreement.

A provision for restructuring costs is recognised only when the general recognition criteria are met. More specifically, a constructive obligation only arises when a detailed formal plan is in place and it has begun or been announced to those affected by it. A board decision is not enough. Restructuring provisions should include only direct expenditures caused by the restructuring, not costs that associated with the ongoing activities of the entity.

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