Transcript No Slide Title

ACCOUNTING STANDARD 29
PROVISIONS,
CONTINGENT LIABILITIES
AND
CONTINGENT ASSETS
B P Rao, FCA
Applicability of AS-29

Issued in 2003.

Applicable WEF 01/04/04

Mandatory in entirety for Level I enterprises

Applicable for SMCs with certain relaxations regarding disclosure.

Specified Paragraphs of AS 4 on contingencies stand withdrawn
except to the extent they deal with impairment of Financial assets
and are not covered by AS 28.
AS 29

ON AS-30 FI-Recognition BECOMING MANDATORY, FOLLOWING
WILL BE WITHDRAWN

In AS-4 all balance paras pertaining to Contingencies (balance after AS29 was introduced was only reg. Impairment of assets not dealt with by any
other standard like “Impairment of Receivable”).
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OBJECTIVE:
 To ensure appropriate recognition criteria
and measurement bases for
 provisions
 contingent liabilities
 Disclosure
requirements
to
understand their nature, timing & amount.
enable
users
to
 Accounting for contingent assets
 Provision for restructuring costs
AS 29
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SCOPE
Applicable to all Provisions, Contingent Liabilities and Contingent
Assets other than:

Financial instruments carried at fair value

Insurance contracts with policy holders

Those covered by other AS like




AS
AS
AS
AS
7 (Construction Contracts)
22 (Taxes on Income), etc.
19 (Leases). In case an Operating Lease has become Onerous, AS 29 would apply.
-15 (Employee Benefits)

Executory

[Onerous contracts
[Contracts under which neither party has
performed any of its obligations or both parties have partially performed
their obligations to an equal extent]


AS 29
contracts
(Cost >Benefit from contract) are covered by AS-29]
Contract where the unavoidable costs of meeting the obligations under the
contract exceed the expected economic benefits.
Provision to be recognised [as per ASI-30]
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ONEROUS CONTRACTS
Case Study 1:




Contract to purchase 1 million units of gas @ 0.23/unit [Contract price is Rs.230,000].
Current market price for a similar contract is 0.16/unit [Market price is Rs.160,000].
Contract to sell to a third party @ 0.18 per unit [Sale price is Rs.180,000].
In the event of cancellation of contract, penalty to be paid is Rs.55,000.
What should be the treatment under AS -29 ?
Ans.
Liability of Rs.50,000 is to be provided for,
Being Lower of:
 Cost of fulfilling the contract i.e. Rs.50000
OR
 Penalty cost of Rs.55,000.
AS 29
B P Rao, FCA
[Rs.230000 – Rs.180000]
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DEFINITIONS
A PROVISION
is a liability
which can be measured only by using a substantial degree of
estimation. (Quantum not certain - differs with ACCRUAL to this extent)
A LIABILITY
is a present obligation of the enterprise arising from past events,
the settlement of which is expected to result in an outflow of
economic resources.
PRESENT OBLIGATION - an obligation is a present obligation if,
based on the evidence available, its existence at the B/S date is
considered probable, i.e., more likely than not.
AS 29
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SETTLEMENT OF PRESENT OBLIGATION







AS 29
Either
Payment of cash
transfer of other assets
Provision for services
Replacement with another obligation
conversion to equity
waiver or forfeiture
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PROVISION:
AS 29 defines Provision as a liability which can
be measured only by using a substantial
degree of estimation.
RECOGNITION CRITERIA
PROVISION =
AS 29
Present obligation
from
past event
+
Outflow
Is
probable
B P Rao, FCA
+
Ability
to
measure
+
No
alternative
settlement
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PRESENT OBLIGATION AND PAST EVENTS:
Condition 1Existence of a present obligation arising from a past
obligating event is essential for classification as a
provision.
Examples where provision is not required:
 No provision for cost to be incurred to operate in future.
 No provision for constructive obligations
 No provision for possible obligation which may arise at a
later date due to change in legislation
 Provisions should not be made to spread out expenses just
to produce reasonably level charge every year
AS 29
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PRESENT OBLIGATION AND PAST EVENTS - COMPARISON WITH IFRS
IAS 37 covers constructive obligations also.
Under AS-29, an obligating event is one which creates an obligation that
results in the enterprise having no other alternative but to settle the
obligation
Whereas, as per IAS 37, an obligating event is one which creates a legal or
constructive obligation that results in the enterprise having no other
alternative but to settle the obligation
 Legal obligation is one which derives either from:

Terms of a contract

Legislation; or

Other operation of law
 Constructive obligation derives from an entity’s actions where:
 By established pattern of past practice, published policies or sufficiently
specific current statement, the entity has indicated to other parties that
it will accept certain responsibilities; and
 As a result, the entity has created a valid expectation on the part of
those other parties that it will discharge those responsibilities.
AS 29
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PRESENT OBLIGATION AND PAST EVENTS

Condition 2 – Probable Outflow :
It is extent of an obligation to transfer economic benefits, i.e.,
obligation is more likely than not to occur, which means that the
chance that a transfer of economic benefits will occur is over 50%
PPR Analysis
Probable
> 50%
Chance of occurrence
Provision
Possible
<50%
Chance of occurrence
Contingent Liability
Remote

AS 29
Almost 0%
Disclose CL or forget
Condition 3 – Reliable Estimate:
Recognition of provision requires a greater degree of estimation.
In extremely rare cases where no reliable estimate can be made, it
implies that a liability exists which cannot be recognised. This liability
would be a contingent liability.
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MEASUREMENT OF PROVISION

Amount to be “Best Estimate” required to settle present obligation at BS date.

Estimate based on
 management’s judgment,
 supplemented by experience on similar transactions &
 Reports by independent experts.

Provision not to be discounted [IFRS requires discounting]

It is Pre tax. Tax consequences of provision & its changes, are dealt in AS 22.

Risks & uncertainties to be considered using PRUDENCE as in Framework.

Likely gains from expected disposal of assets are not to be considered
AS 29
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MEASUREMENT OF PROVISION
 Future events that may affect the amount
required to settle an obligation should be
considered in arriving at the amount of
provision
where
there
is
sufficient
objective evidence that such future
events will occur.

CHANGES IN TECHNOLOGY
Development of completely new technology to be taken into account
only where there is sufficient evidence that it will be available &
effective for the required task.

CHANGE IN LEGISLATION
New legislation to be reflected in the measurement of a provision for an
existing obligation when there is sufficient objective evidence that the
legislation is virtually certain to be enacted.
AS 29
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MEASUREMENT OF PROVISION
 REIMBURSEMENT OF EXPENSES

Do not recognise reimbursement of expenditure required to
settle a provision unless there is a virtual certainty that it will be
received.
 If recognized , it will be a separate asset.


Reimbursement should not exceed the amount of provision
In P&L a/c, Reimbursement can be netted off against expense
provision.
 Changes in Provisions



AS 29
Provisions should be reviewed at each balance sheet and
adjusted to reflect current best estimates.
If provision is no longer required the provision should be reversed.
FUTURE OPERATING LOSSES
 Do not recognise provision for future operating losses
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USE OF PROVISIONS

A provision should be used only for
expenditures for which the provision was
originally recognised.

Only expenditures that relate to the original
provision are adjusted against it.

Adjusting expenditures against a provision that
was originally recognised for another purpose
would conceal the impact of two different
events.
AS 29
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RESTRUCTURING
 RESTRUCTURING
is a programme that is planned &
controlled by management, and materially changes either:
a the scope of a business undertaken by an enterprise; or
b the manner in which that business is conducted.
 RESTRUCTURING
 No obligation arises for the sale of an operation until there
is a binding sale agreement
 Recognise a provision for re-structuring cost only if the
recognition criteria as stipulated in the beginning is met
AS 29
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CONTINGENT LIABILITY:
a)A possible obligation that arises from past event and
existence of which will be confirmed only by occurrence
or non-occurrence of one or more uncertain future
events not wholly within the control of the enterprise or
b) A present obligation that arises from past events but is
not recognized because:
i)
It is not probable that an outflow of resources
embodying economic benefits will be required to settle
the obligation: or
ii) A reliable estimate of the amount of the obligation
cannot be made.
AS 29
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CONTINGENT LIABILITY:
Contingent =
Liability
AS 29
Possible
obligation
from past
event
+
B P Rao, FCA
Dependent
upon a
contingent
event
+
Future
event
not
within
control
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CONTINGENT LIABILITIES (CL)


An enterprise should not recognise a CL.

Where an enterprise is jointly & severally liable for an
obligation,

A CL is disclosed, unless the possibility of an outflow of
resources embodying economic benefits is remote.

The part of obligation that is expected to be met by other
parties is treated as a CL.

The remainder, being the entity's share is to be recognised
as a provision, except in the extremely rare circumstances
where no reliable estimate can be made.
Conduct a continuous review of CL.
Characteristics of an item that was originally reckoned as
a CL may change over time. In turn, this may lead to
recognition of a provision, in line with recognition criteria.
AS 29
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CONTINGENT ASSET:
A possible asset arises from past events and
existence of which is dependent upon a
contingent event.
Contingent =
Asset
AS 29
Possible
asset
from past
event
+
B P Rao, FCA
Dependent
upon a
contingent
event
+
Future
event
not
within
control
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CONTINGENT ASSETS (CA)

An enterprise should not recognise a CA. CA are not

CAs usually arise from unplanned or other unexpected events
that give rise to the possibility of an inflow of economic
benefits.

When the realisation of income is virtually certain, then the
related asset is not a CA & its recognition is appropriate.

CAs are assessed continually & if it has become virtually
certain that an inflow of economic benefits will arise, the asset
& the related income are recognised in F/Ss of the period in
which the change occurs.
AS 29
disclosed in the financial statements. It may be
disclosed in the report of the approving authority.
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DECISION TREE
Start
Present obligation as a result of an
obligating event ?
No
Yes
Probable
outflow ?
Yes
Remote ?
No
Yes
Yes
No
Yes
Reliable
estimate ?
No
Possible
Obligation ?
No (rare)
Disclose
contingent
liability
Do
nothing
Provide
AS 29
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DISCLOSURE REQUIREMENTS
For each class of provision, following should be disclosed
PARA-66

Carrying amount –opening and closing

Additions [including to existing provisions

Amounts used during the period

Reversals, if any
PARA-67

Brief description of nature of obligation & expected timing of probable
outflow of resources

Uncertainties about outflows & Major assumptions reg. future events

Expected Reimbursements [State the amount of any assets recognized]
Excise
Trade / other
litigation
Environment
Warranty
Total
Opening Balance
Additions
Utilisation
Reversals
Closing Balance
AS 29
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DISCLOSURE REQUIREMENTS
Unless the possibility of any outflow is remote, For each class of
contingent liability, following should be disclosed
 Brief description of the nature a
 where practicable
 Estimate of its financial affect
 Indications of uncertainties involved
 Possibility of reimbursements
 Any information not practicable –such fact
Exemption from Disclosures in extremely rare cases. However
general nature of dispute, fact that and reason for non disclosure
to be given.
AS 29
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DISCLOSURE REQUIREMENTS
 In extremely rare cases, disclosure of some or all
of the information
 required by paragraphs 66-70 can be expected to
prejudice seriously the position of the enterprise
in a dispute with other parties on the subject
matter of the provision or contingent liability.
 In such cases, an enterprise need not disclose the
information, but should disclose the general
nature of the dispute, together with the fact that,
and reason why, the information has not been
disclosed.
AS 29
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RECOGNITION OF PROVISION

Provision for warranties?
Provision to be scientifically determined based on trend analysis & other technical
estimates. Will require assistance of actuary.

Contaminated land –Legislation Virtually Certain to be Enacted?
Contamination is an obligation event, virtual certainty of enactment is probable and
hence an obligating event exists as at the balance sheet date.
Provision should therefore be made.

Credit card bonus points scheme?
Obligation arises as soon as customer becomes entitled to reward points although
utilization may be by the customer at a future date.
Provision should therefore be made.

Staff retraining costs as a result of change in legislation?
On account of change in legislation an enterprise will need to retrain large proportion
of staff. As at balance sheet date, no training has been imparted.
No provision is required, since obligating event viz., training has not occurred as
at the balance sheet date.
AS 29
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RECOGNITION OF PROVISION
 Case Study:
A furnace has a lining that needs to be replaced every 5 years
for technical reasons. As at March 31, 2009 has been used for 3
years.
What should be the treatment under AS -29 ?
 Cost of replacing the lining is not recognized because
 No obligation to replace the lining exists independently of
the Company’s future actions.
 Intention to incur the expenditure depends on the Company
deciding to continue operating the furnace or to replace the
lining.
AS 29
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COMPARISON OF AS 29 WITH IAS 37

IAS 37 permits discounting of provisions.
AS 29 does not permit any discounting

IAS 37 requires provisions for onerous contracts to be recognized
AS 29 does not mandate it.

IAS 37 requires provisioning on constructive obligation on restructuring.
AS 29 prohibits the same.

IAS 37 requires disclosure of Contingent Assets in FS.
AS 29 allows such disclosure only in approving authority’s Report.

IAS 37 provides basis & statistical methods for arriving at “best estimate” of expenditure for which
provision is recognised.
AS 29 doesn’t contain any such guidance & relies on management judgment.

IAS 37 defines only “obligation” but not “present obligation” & “possible obligation”.
AS 29 defines present obligation and possible obligation as well.
AS 29
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EXAMPLES
WARRANTIES:
A manufacturer gives warranties at the time of sale to
purchasers of its product. Under the terms of the contract
for sale the manufacturer undertakes to make good, by
repair or replacement, manufacturing defects that become
apparent within three years from the date of sale.
The obligating event is the sale of the product with a
warranty
 Conclusion - A provision is recognized for the best estimate
of the costs of making good under the warranty products
sold before the balance sheet date
AS 29
B P Rao, FCA
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EXAMPLES
 REFUND POLICY:
A retail store has a policy of refunding purchases
by dissatisfied customers, even though it is under
no legal obligation to do so. Its policy of making
refunds is generally known.
 The obligating event is the sale of the product.
 An outflow of resources embodying economic
benefits in settlement- Probable, a proportion of
goods are returned for refund.
 Conclusion - A provision is recognized for the
best estimate of the costs of refunds.
AS 29
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EXAMPLES
 Legal Requirement to Fit Smoke Filters
 Under new legislation, an enterprise is required
to fit smoke filters to its factories by 30
September, 2005. The enterprise has not fitted
the smoke filters.
 (a) At the balance sheet date of 31 March, 2005
There is no obligation because there is no
obligating event either for the costs of fitting
smoke filters or for fines under the legislation.
Conclusion - No provision is recognized for the
cost of fitting the smoke
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EXAMPLES
 (b) At the balance sheet date of 31 March, 2006
There is still no obligation for the costs of fitting smoke
filters because no obligating event has occurred.
However, an obligation might arise to Provisions, Contingent
Liabilities and Contingent Assets 661 pay fines or penalties
under the legislation because the obligating event has
occurred
Assessment of probability of incurring fines and penalties by
non-compliant operation depends on the details of the
legislation and the stringency of the enforcement regime.
Conclusion - No provision is recognized for the costs of
fitting smoke filters. However, a provision is recognized for
the best estimate of any fines and penalties
AS 29
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AS-29 ILLUSTRATIVELY
Extract of the B.H.E.L Annual Report 2007-08
 Claims by/against the Company
(i) Claims for liquidated damages against the
Company are recognized in accounts based on
management’s assessment of the probable
outcome with reference to the available
information supplemented by experience of
similar transactions.
(ii) Claims for export incentives/duty
drawbacks/duty refunds and insurance claims
etc. are taken into accounts on accrual.
AS 29
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BHEL ANNUAL REPORT 2007-08
(iii) Amounts due in respect of price
escalation claims and/or variations in
contract work are recognized as
revenue only when there are conditions
in the contracts for variations and/or
evidence of the acceptability of the
same from customers. However,
escalation is restricted to intrinsic
value.
AS 29
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BHEL ANNUAL REPORT 2007-08
 Provision for Warranties
(i) For construction contracts entered into on or
after 01.04.2003:
Provision for contractual obligation is maintained at
2.5% of the contract value on completion of trial operation.
(ii) For all other contracts:
Provision for contractual obligations in respect of
contracts under warranty at the year end is maintained at
2.5% of the value of contract. In the case of contracts for
supply of more than a single product 2.5% of the value of
each completed product is provided.
(iii) Warranty claims/ expenses on rectification work are
accounted for against natural heads as and when incurred
and changed to provisions in the year end.
AS 29
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BHEL ANNUAL REPORT 2007-08
 Contingent Liabilities:
1.(a) Claims against the company not
acknowledged as debt:
Income Tax pending appeals (net of
provisions) Rs.28.41 crores (previous year
Rs.48.72 crores) against which Rs. 0.01 crore
(previous year Rs. 0.01 crore) has been paid
under protest and including under the head
deposits- others.
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BHEL ANNUAL REPORT 2007-08
(b) Sales Tax demands Rss.295.18 crores
(previous year Rs.328.60 crores) against
which Rs.78.03 crores (previous year
Rs.88.90 crores) has been paid under
protest/court orders and included under the
head advances recoverable.
(c) Excise Duty demands Rs.140.23 crores
(previous year Rs.149.18 crores), against
which Rs.12.49 crores (previous year Rs.6.52
crores) has been paid under protest/court
orders and included under the head advances
recoverable.
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BHEL ANNUAL REPORT 2007-08
(d) Custom Duty demands Rs. Nil (previous
year Rs. 0.76 crore)
(e) Court / Arbitration cases Rs.76.17 crores
(previous year Rs.82.47 crores)
(f) Liquidated Damages Rs.809.53 crores
(previous year Rs.257.22 crores)
(g) Counter claim by contractors Rs.40.99
crores (previous year Rs.40.40 crores).
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BHEL ANNUAL REPORT 2007-08
(h) Others Rs.56.31 crores (previous year Rs.47.65 crores).
(g) Counter claim by contractors Rs.40.99 crores (previous
year Rs.40.40 crores).
(h) Others Rs.56.31 crores (previous year Rs.47.65 crores).
(i) In view of the various court cases / litigations and claims
disputed by the company financial impact as to outflow of
resources is not ascertainable at this stage.
2. Bills discounted under IDBI scheme outstanding at the close
of the year amount to Rs.0.40 crore (previous year Rs.1.78
crores).
AS 29
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INFOSYS ANNUAL REPORT 2008-09
 An extract from the Infosys Annual Report for the year
2008-09
(a) For Post- sales Client Support and Warranties:
The company provides its clients with a fixed period
warranty for corrections of errors and telephone support on
all its fixed-price and fixed-timeframe contracts.
Costs associated with such support services are accrued at
the time when related revenues are recorded and included
in cost of sales.
Company estimates such costs based on historical
experience and the estimates are reviewed annually for any
material changes in assumptions.
AS 29
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INFOSYS ANNUAL REPORT 2008-09
 For onerous contracts
Provisions for onerous contracts are
recognized when the expected benefits to be
derived by the Company from a contract are
lower than the unavoidable costs of meeting
the future obligations under the contract.
The provisions is measured at lower of the
expected cost of terminating the contract and
the expected net cost of fulfilling the
contract.
AS 29
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COMPENDIUM OF OPINIONS
 Treatment of contingency relating to
additional power tariff demands by a
State Government.
A company has set up a unit to manufacture
Ferro alloys. Its economics was based on the
policies and assurances of the State
Government to provide certain incentives.
One of the incentives was to provide power at
a tariff which was about Te.0.50 per unit for a
period of 5 years.
AS 29
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COMPENDIUM OF OPINIONS
 The State Government later unilaterally
withdrew the notification on power
tariff and sought to levy tariff at the
revised rates. The revision of the
notification of the government was
challenged in the High Court, which
stayed the application of the order
pending full hearing.
AS 29
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COMPENDIUM OF OPINIONS
 According to the querist, if the company
accounts for the tariff at the revised rates, it
would be a sick industrial company under
section 3(1)(0) of the Sick Industrial
Companies (Special Provision) Act, 1985, and
if it does not account for the tariff at the
revised rates, it would result into payment of
income tax because the electricity expenses
due to concessional tariff is lower as
compared to the revised tariff.
AS 29
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