case 12-3
Provisions and Contingencies
Scenario 1
Fact: Energy Inc. (Energy, or the Company), which operates in the oil industry, is a U.S. subsidiary of a U.K. entity that prepares its financial statements in accordance with IFRS and U.S. GAAP. A draft law in a country where Energy operates in, which requires a cleanup of land already contaminated, will possibly be enacted shortly after the year-end.
Issues: Should Energy recognize a provision, (i) in reporting under IFRSs, and (ii) in accordance with U.S. GAAP?
Analysis: (i) Under IFRSs, Energy should recognize a provision for the cleanup costs in its 20x1. IAS 37-14 states a provision shall be recognized if “(a) an entity has a present obligation, (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made.” When it is not clear if there is a present obligation, IAS 37-15 also defines a present obligation as obligation that “more or likely than not is risen by a past event after taking accounting of all available evidence”. Moreover, IAS 37-22 also specifically provides that “where details of a proposed new law have yet to be finalized, an obligation arises only when the legislation is virtually certain to be enacted as drafted”. As it is virtually certain that the law will be enacted shortly after year-end, it is highly possible the Company will be required to clean up the contamination. The amount of obligation is also estimable, as the Company has cleaned up contaminations in other countries in which it operates. As a result, Energy should recognize a provision. (ii) Under U.S. GAAP, Energy should recognize a loss for the cleanup costs in its 20x1 financial statements. ASC 450-20-25-2 provides that “an estimated loss from a loss contingency shall be accrued by a charge to income if (a) information available before the financial statements are issued indicates it is probable that a liability had
Scenario 1
Fact: Energy Inc. (Energy, or the Company), which operates in the oil industry, is a U.S. subsidiary of a U.K. entity that prepares its financial statements in accordance with IFRS and U.S. GAAP. A draft law in a country where Energy operates in, which requires a cleanup of land already contaminated, will possibly be enacted shortly after the year-end.
Issues: Should Energy recognize a provision, (i) in reporting under IFRSs, and (ii) in accordance with U.S. GAAP?
Analysis: (i) Under IFRSs, Energy should recognize a provision for the cleanup costs in its 20x1. IAS 37-14 states a provision shall be recognized if “(a) an entity has a present obligation, (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made.” When it is not clear if there is a present obligation, IAS 37-15 also defines a present obligation as obligation that “more or likely than not is risen by a past event after taking accounting of all available evidence”. Moreover, IAS 37-22 also specifically provides that “where details of a proposed new law have yet to be finalized, an obligation arises only when the legislation is virtually certain to be enacted as drafted”. As it is virtually certain that the law will be enacted shortly after year-end, it is highly possible the Company will be required to clean up the contamination. The amount of obligation is also estimable, as the Company has cleaned up contaminations in other countries in which it operates. As a result, Energy should recognize a provision. (ii) Under U.S. GAAP, Energy should recognize a loss for the cleanup costs in its 20x1 financial statements. ASC 450-20-25-2 provides that “an estimated loss from a loss contingency shall be accrued by a charge to income if (a) information available before the financial statements are issued indicates it is probable that a liability had