3. Introduction
Liability in the financial statement attracts much attention than other financial statements items
such as assets and equity as it shows the company’s present obligations. As per the
Framework for preparation and presentation financial statements published by international
Accounting Standard Board (IASB) liability is defined as a present obligation of company which
resulting from a past event and settlement of such obligation may result in a out flow of
resources that have economic benefits.
Further the framework discusses the need for the distinction of the present obligation which
leads to liability and a future commitment which might be a contingent liability in the financial
statements.
The IASB has introduced several standards which are dealing with different types of liabilities.
Those are,
IAS 19 Employee benefits
IAS 32 Financial Instruments - presentation
IAS 39 Financial Instruments – Recognition and measurement
IFRS- 2 Share Based payments
IFRS 7 – Insurance contracts
Due to the complexity involved in recognition and measurement of liabilities other than those
covered from above mentioned standards, IASB introduced a new standard IAS 37, Provisions,
contingent liabilities and contingent assets where it requires to identify certain liabilities as
provisions and contingent liabilities.
However such standard contains several confusions when applying the provisions of the
standard. Mainly there are two complicated and vague areas in IAS 37. Those are,
As per the provision of IAS 37, an entity needs to recognize a provision in its financial
statements at the best estimated amounts. However the standard fails to give proper
guidance as to the meaning of best estimate. The standard explain best estimate as the
amount that is required to settle the present obligation as of the balance sheet date.
However due to the uncertainty and other factors such as the judgment and the
experience of the management the best estimate may be change in different
circumstances and the provision amount also may change in the financial statements.
IAS 17 does not provide proper guidance as to what kind of costs needs to be included
in when measuring liabilities. Thus some entities include only the direct costs applicable
4. to such liability while some entities use only the incremental cost. Further some entities
consider indirect cost as well in measuring liabilities. Moreover some entities measure
the liability based on the amount that they needs to pay for a contractor to fulfill the
obligation.
IAS 37 – Provisions contingent liabilities and contingent assets was developed by IASB by a
joint project with ASB in 1998. Subsequent to the standard the IASB released several
interpretations to IAS 37, those are
IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities
IFRIC 3 - Emission Rights (Withdrawn in June 2005)
IFRIC 5 - Rights to Interests arising from Decommissioning, Restoration and
Environmental Rehabilitation Funds
IFRIC 6 - Liabilities arising from Participating in a Specific Market – Waste Electrical and
Electronic Equipment
( http://www.iasb.org)
After those interpretations it was understood that the initial standard needs to be modified to
suits for the liabilities arises from modern business transactions. Thus IASB issued a Exposure
draft for IAS in several times and in 2010 finally.
The objectives of the exposure draft is as follows,
To align the criteria in IAS 37 for recognizing a liability with those in other IFRSs.
To remove some differences between IAS 37 and US Generally Accepted Accounting
Principles (GAAP)
To Clarify measurement of liability in IAS 37 further
(http://www.iasplus.com/agenda/converge-ias37.htm#ed)
It can be noted that the guidance given in the standard with regard to measurement of
provisions contingent liabilities and contingent assets is not clear and gives vague conclusions.
For example the standard suggest various ways in dealing for uncertainty when making
provisions such as
expected value (or probability-weighted) method
mid-point of the range of possible outcomes
estimate of the individual most likely outcome
Those method suggested by the standard include lots of problems where the possible outcome
may be misstated.
Due to the various issues and concerns of the users of the financial statements and companies
IASB took steps to issue an exposure draft with the intention of addressing such concerns.
Accordingly first exposure draft was issued in 2005 and with the proposals of several parties it
was reissued in 2010.
5. As per the exposure draft issued by IASB in 2010 there are several differences when measuring
liabilities when compared with existing IAS 37,
Initial Recognition
IAS 37 proposes the provision amount that is recognized as liability is recognized at the
best estimate amount.
However the exposure draft for IAS 37 proposes that the liability in the financial
statements to be recognized on the basis that the amount that the entity will pay
rationally at the end of the financial period to settle such obligation.
Further it provide guidance that the amount rationally pay would be lower of
o The present value of the cash or other resources that needs to utilize to settle the
obligation in future.
o The amount that the company may have to pay if the obligation is cancelled.
o The amount that the company may have to pay if the obligation is transferred to a
third party.
It can be noted that there is a significant different between IAS 37 and IAS 37 exposure draft
with regard to the measurement of liabilities. Accordingly the IASB s view on liability seems to
be changed significantly through this exposure draft.
Further in the exposure draft it gives separate and clear guidance as to the determination of
present value of resources, how to determine the cost of cancellation the obligation and the
amount needs to pay when transferring the obligation to a third party.
Subsequent measurement
When considering the subsequent measurement IAS 37 does not provide proper guidance as to
how the entity should subsequently measure the provisions and contingent liabilities.
However IAS 37 exposure draft states that the company needs to make adjustments to the
carrying value of liabilities which recognized at the initial point at each financial reporting period
based on the amount that the company rationally pays to settle the obligation as of such date.
The resulting amount needs to be recognized to the income statements as a part of the
borrowing cost.
Apart from IAS 37 in some instances IASB proposes different measurement basis for different
types of liabilities. As provided above different standards provide various measurement bases
making recognitions of liability being a complex area. Among other liabilities in IAS 19,
Employee benefit the IASB guides the post employee benefit liability to be measured using
projected unit credit method which is an actuarial valuation technique.
6. Problems and possible solutions
Thus it can be noted that providing guidance for measurement and recognition of liabilities in the
financial statements is a challenging task to IASB. The main reason for such problems are
complex business transaction taken place in the business world in the modern business
environment for which IASB has not been able to address properly. Moreover the expectations
of the user groups of financial statements has not been properly identified when developing
standards relating to liabilities and thus such standards needs to be change to full fill those
expectations.
In order to overcome from such problems IASB can use following actions.
IASB can start a useful and effective discussion with the user groups of the financial statements
and should identify the expectations of those parties. Thereafter Guidance for recognition and
measurement of liabilities needs to be build up to suit for those expectations as well as
substance of those business transactions.
Further exposure drafts needs to be opened for more discussions among the users of the
financial statements. More specifically attention of professional firms and academics needs to
be obtained where practical knowledge and theoretical aspect can be discussed
Apart from those attention needs to be given to the current business and economic trends
prevail in globally and how those factors affect to the ways in which financial reporting is done.
By applying discussed recommendations IASB will be able to address to measurement and
recognition problems for liabilities in the International Financial Reporting Standards.
7. Reference
IASB,2010, Exposure draft ED/2010/1,IASCF
IASB,2001, International accounting Standards 37 Provisions Contingent liabilities and
contingent assets, IASCF
IASB 2012, International Accounting Standard Board, United kingdom, <
http://www.IFRS.org/> viewed on 29, March 2012.
Ernst & Young 2012, Ernst & Young LLP 2012, united kingdom, < http://www.ey.com/>
viewed on 30, March 2012.
Deloitte global services limited 2012, Deloitte global services limited, United Kingdom, <
http://www. iasplus, com/> viewed on 30, March 2012.
Gee Paul, Alan Sugden, Interpreting Company Reports 10th edition, 2008, Pearson
Education.
ICAEW 2012, ICAEW, United Kingdom, < http:// www. ICAEW. org/> viewed on 20,
March 2012.
