How to
account for litigation? I have touched upon this topic from different
angles. When I was an attorney, clients asked to evaluate the risk of
litigation and to put a total amount on such risk. When negotiating
financing contracts, I often faced representations and warranties
about litigation risk. The most important angle, the accountant
perspective, is still missing in my career. It’s not very likely
that I will ever be an accountant, but you never know...
Anyway,
knowing the IFRS rules about this topic helps for any of the above
perspective.
_____________________________________________________________________
“Perhaps
you’re a scholar,” said the prize-fighter, after a moment’s
reflection.
“I
have been at school; but I didn’t learn much there,” replied the
youth. “I think I could bookkeep by double entry, “he added,
glancing at the card.
Double
entry! What’s that?”
“It’s
the way merchants’ books are kept. It is called so because
everything is entered twice over.”
“Ah!”
said Skene, unfavorably impressed by the system; “once is enough
for me.”
(George
Bernard Shaw, Cashel Byron’s Profession)
______________________________________________________________________
Provisions
A
provision, in IFRS accounting jargon, is a liability of uncertain
timing or amount. If you would like recognize a provision, three
cumulative conditions must be met:
- A present obligation results from a past event. To make it more pompous, IAS names this past event an “obligating event”.
- An outflow of resources is probable.
- You can estimate the amount of the obligation reliably.
Four
principles guide you when measuring the provision: You should
- take risks and uncertainties into account;
- discount the provisions if the time value of money is relevant;
- take future events, especially of legal and technological nature, into account;
- not take gains from the expected disposal of assets into account.
The
final amount is then a “best estimate”, based on
management judgment, experience of similar transactions, and reports
from independent experts. In addition, where many outcomes are
possible, a weighted average shall be determined (“expected
value”).
Provisions
shall be reviewed and readjusted at the end of each financial year.
Specific
examples of provisions include future operating losses, onerous
contracts (= the contract’s costs exceed its benefits), and
restructurings.
Contingent
liabilities
A
contingent liability is
- a possible obligation that arises from past events but depends on uncertain future events not wholly controlled by the company, or
- a present obligation where it is not probable that such obligation requires economic resources for its settlement or where the amount of the obligation cannot be measured reliably.
Contingent
liabilities are not recognized on the firm’s balance sheet. By
contrast, they are disclosed as a contingent liability, unless the
outflow of economic resources is remote.
Contingent
assets
A
contingent asset is a possible asset that arises from past events and
whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly
owned within the control of the entity.
Firms
shall not recognize a contingent asset on its balance sheet. However,
when an inflow of economic benefits is probable, the contingent asset
shall be disclosed.
Disclosure
In its
financial statements, the company must disclose some basic
information about its provisions, contingent liabilities, and
contingent assets as follows:
 |
| Disclosure under IAS 37 |
Resource:
- IAS 37 – Provisions, Contingent Liabilities, and Contingent Assets
