IAS 37 Provisions

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Asnake E
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IAS 37 Provisions

Post by Asnake E »

Hi,

Would you please help me on the following

1. Assume the entity provided for warranties in the previous year and in the current year some of the warranties are exercised and paid for. My question is
should the remaining warranty reversed by crediting retained earnings or profit or loss as income/deduction from expense?

2. IAS 37 par 59 states that ‘If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision shall be reversed’’

My question is
where the provisions was of the previous years, should the reversal credit retained earnings or profit or loss as income/deduction from expense?
JRSB
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Re: IAS 37 Provisions

Post by JRSB »

Are you thinking that the prior year provision being too high was a prior period error caused by incorrect inputs (based on info known at the time), or simply an estimation error that wasn't revealed until information was received this year?
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Marek Muc
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Re: IAS 37 Provisions

Post by Marek Muc »

In this case it seems like utilising this provision, so in essence the entry is:
CR cash (payments triggered by warranty repairs/replacements etc)
DR provision

At the same time, don't forget to set up a provision for this year's sales :)
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exIFRS
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Re: IAS 37 Provisions

Post by exIFRS »

I assume the numbers we are talking about are not material. In a way I think you are thinking about it the wrong way, a warranty is much like an allowance for doubtful debts, you are interested in the value of the balance sheet item, not the individual expenses. You have got to look at at IAS37.59 as a whole. "The provision shall be reviewed each period and adjusted to reflect the current best estimate". You just calculate the estimated provision for warranties required now, making an adjusting entry that simply incorporates any over or under provision from the previous year and just move on.

Again it just seems very unlikely it is material, if it is you may need to consider whether an error has been made. This could be because the company was "taking a bath" or whatever. Warranty provisions would be one of a number of accounts used to reduced profit. In this case retrospective adjustment, because effectively you mislead users of your financial statements as to your actual profits in a previous period.

The second half of paragraph 59 (which you quote) really applies when you no longer need the provision at all (these would be more "one-off provisions" like restructuring or onerous contracts). When these are reversed you would recognize a gain on reversal of provision, as it is no longer relevant.
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Marek Muc
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Re: IAS 37 Provisions

Post by Marek Muc »

I like the analogy to doubtful debts and for large number of homogeneous contracts this will work fine, i.e. expense in P/L every warranty expenditure as incurred, and then adjust the closing balance of provision at the reporting date

but if we're talking about large dissimilar contracts, don't you think that the approach as suggested by me is best? I.e. utilisation of provision for every expenditure, and recording a new provision for each completed contract? And I can easily imagine that such a provision is released as per para 59 after the warranty period ends. Here I would make an analogy to decommissioning provision, where this provision can be drilled down to a specific asset

this is obviously assuming that there was no error in setting up the provision in the first place
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exIFRS
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Re: IAS 37 Provisions

Post by exIFRS »

You're right my assumption was that we are talking about a number of homogenous transactions. The assessment would be different if we are talking about a small number of high value heterogeneous transactions.
Asnake E
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Re: IAS 37 Provisions

Post by Asnake E »

Thank you.

Please note that my doubt is on the balance remaining after utilization of the provision.

So are you saying that

1. When the reversal is due to prior period error caused by incorrect inputs (based on info known at the time), the reversal should be treated as restatement of the previous year errors as per IAS 8 and
2. when the reversal is owing to an estimation error that wasn't revealed until information was received this year, the reversal should be released to the PL as income?
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exIFRS
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Re: IAS 37 Provisions

Post by exIFRS »

My view (happy to hear alternatives):

1. I would only treat it as an error under IAS 8 if it meets the definition as per IAS 8.5 prior period error and only if material by size or nature.
2. If the related item no longer exists I would close out the provision to "other income" again unless it was individually material.
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Marek Muc
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Re: IAS 37 Provisions

Post by Marek Muc »

yes, just in point 2/ don't say 'estimation error' but rather 'difference between outcome and estimation' - these are not the same IMO

and generally don't rush into saying that this was an error, there's nothing unusual in actual outcomes being different from estimates
Asnake E
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Re: IAS 37 Provisions

Post by Asnake E »

I thank you very much for your explanations. I see that you are experts in IFRS.
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