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Public Finance Management Act, 1999 (Act No. 1 of 1999)

Notices

Standards of Generally Accepted Municipal Accounting Practice (GAMAP) in terms of Section 91

GAMAP 19 : Provisions, Contingent Liabilities and Contingent Assets

 

Introduction

 

Standards of Generally Accepted Municipal Accounting Practice (GAMAP)

 

The Accounting Standards Board (Board) is required in terms of the Public Finance Management Act, Act No. 1 of 1999, as amended (PFMA), to determine generally recognised accounting practice referred to as Standards of Generally Recognised Accounting Practice (GRAP).

 

The Board must determine GRAP for:

(a) departments (national and provincial);
(b) public entities;
(c) constitutional institutions;
(d) municipalities and boards, commissions, companies, corporations, funds or other entities under the ownership control of a municipality; and
(e) Parliament and the provincial legislatures.

 

The above are collectively referred to as ‘entities" Standards of GRAP.

 

The Board considers that the Standards of GAMAP constitute GRAP for municipalities.

 

GAMAP is an interim solution until such time as it is replaced by a Standard of GRAP.

 

Any limitation of the applicability of specific Standards is made clear in those Standards.

 

The Standard of GAMAP on Provisions, Contingent Liabilities and Contingent Assets is set out in paragraphs .01 - .107. All paragraphs in this Standard have equal authority. The authority of appendices is dealt with in the preamble to each appendix. This Standard should be read in the context of its objective, the Preface to Standards of GRAP, the Preface to Standards of GAMAP and the Framework for the Preparation and Presentation of Financial Statements.

 

Reference may be made here to a Standards of GRAP that has not been issued at the time of issue of this Standard. This is done to avoid having to change the Standards already issued when a later Standard is subsequently issued. Paragraph .12 of the Standard of GRAP on Accounting Policies, Changes in Accounting Estimates and Errors provides a basis for selecting and applying accounting policies in the absence of explicit guidance.

 

Objective

 

The objective of this Standard is to define provisions, contingent liabilities and contingent assets, identify the circumstances in which provisions should be recognised, how they should be measured and the disclosures that should be made about them. The Standard also requires that certain information be disclosed about contingent liabilities and contingent assets in the notes to the financial statements to enable users to understand their nature, timing and amount.

 

Scope

 

.01 An entity which prepares and presents financial statements under the accrual basis of accounting shall apply this Standard in accounting for provisions, contingent liabilities and contingent assets, except :
(a) Those provisions and Contingent liabilities arising from social benefits provided by an entity for which it does not receive consideration that is approximately equal to the value of goods and services provided, directly in return from the recipients of those benefits,
(b) Those resulting from financial instruments that are carried at fair value,
(c) Those resulting from executory contracts, other than where the contract is onerous subject to other provisions of this paragraph,
(d) Those covered by other Standards of Generally Accepted Municipal Accounting Practice, and
(e) Those arising from employee benefits except employee termination benefits that arise as a result of a restructuring as dealt with in this Standard.

 

.02 This Standard applies to financial instruments (including guarantees) that are not carried at fair value.

 

.03 This Standard applies to provisions for restructuring (including discontinuing operations). In some cases, a restructuring may meet the definition of a discontinuing operation. Guidance on disclosing information about discontinuing operations is found in the International Accounting Standard on Discontinuing Operations.

 

Social benefits

 

.04 For the purposes of this Standard "social benefits" refer to goods, services and other benefits provided in the pursuit of the social policy objectives of an entity. These benefits may include:
(a) The delivery of health, education, housing, transport and other social services to the community. In many cases, there is no requirement for the beneficiaries of these services to pay an amount equivalent to the value of these services,
(b) Payment of benefits to families, the aged, the disabled, the unemployed, veterans and others. That is, government entities at all levels may provide financial assistance to individuals and groups in the community to access services to meet their particular needs, or to supplement their income,
(c) Minimum water supplies and/or electricity supplies to members of the community with no requirement to pay an amount approximately equal to the value of the service, and
(d) Waste removal (sanitation and hard refuse) to members of the community with no requirement to pay an amount approximately equal to the value of the service.

 

.05 In many cases, obligations to provide social benefits arise as a consequence of a government's commitment to undertake particular activities on an ongoing basis over the long term in order to provide particular goods and services to the community. The need for, and nature and supply of, goods and services to meet social policy obligations will often depend on a range of demographic and social conditions and are difficult to predict. These benefits generally fall within the "social protection", 'education" and 'health" classifications under the International Monetary Fund's Government Finance Statistics Framework and often require an actuarial assessment to determine the amount of any liability arising in respect of them.

 

.06 For a provision or contingency arising from a social benefit to be excluded from the scope of this Standard, the entity providing the benefit will not receive consideration that is approximately equal to the value of goods and services provided, directly in return from the recipients of the benefit. This exclusion would encompass those circumstances where a charge is levied in respect of the benefit but there is no direct relationship between the charge and the benefit received. The exclusion of these provisions and contingent liabilities from the scope of this Standard reflects the view that both the determination of what constitutes the "obligating event" and the measurement of the liability require further consideration before proposed Standards are exposed. For example, there are differing views about whether the obligating event occurs when the individual meets the eligibility criteria for the benefit or at some earlier stage. Similarly, there are differing views about whether the amount of any obligation reflects an estimate of the current period's entitlement or the present value of all expected future benefits determined on an actuarial basis.

 

.07 Where an entity elects to recognise a provision for such obligations, the entity discloses the basis on which the provisions have been recognised and the measurement basis adopted. The entity also makes other disclosures required by this Standard in respect of those provisions. The Standard of Generally Recognised Accounting Practice on Presentation of Financial Statements provides guidance on dealing with matters not specifically dealt with by another Standard. The Standard of Generally Recognised Accounting Practice on Presentation of Financial Statements also includes requirements relating to the selection and disclosure of accounting policies.

 

.08 In some cases, social benefits may give rise to a liability for which there is:
(a) little or no uncertainty as to the amount, and
(b) the timing of the obligation is not uncertain.

 

Accordingly, these are not likely to meet the definition of a provision in this Standard. Where such liabilities for social benefits exist, they are recognised where they satisfy the criteria for recognition as liabilities (refer also to paragraph .15). An example would be a period-end accrual for an amount owing to the existing beneficiaries in respect of aged or disability pensions that have been approved for payment consistent with the provisions of a contract or legislation.

 

Other exclusions from the scope of the Standard

 

.09 This Standard does not apply to executory contracts unless they are onerous. Contracts to provide social benefits entered into with the expectation that the entity will not receive consideration that is approximately equal to the value of goods and services provided directly in return from the recipients of those benefits are excluded from the scope of this Standard.

 

.10 Where another Standard deals with a specific type of provision, contingent liability or contingent asset, an entity applies that Standard instead of this Standard. For example, certain types of provisions are also addressed in Standards on:
(a) leases (see the International Public Sector Accounting Standard on Leases for guidance. However, as the Standard on leases contains no specific requirements to deal with operating leases that have become onerous, this Standard applies to such cases).
(b) retirement benefit costs (See the International Accounting Standard on Employee Benefits for guidance).

 

.11 Some amounts treated as provisions may relate to the recognition of revenue, for example where an entity gives guarantees in exchange for a fee. This Standard does not address the recognition of revenue. The Standard of Generally Accepted Municipal Accounting Practice on Revenue identifies the circumstances in which revenue from exchange transactions is recognised and provides practical guidance on the application of the recognition criteria. This Standard does not change the requirements of the Standard of Generally Accepted Municipal Accounting Practice on Revenue.

 

.12 This Standard defines provisions as liabilities of uncertain timing or amount. In some instances the term "provision" is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Standard.

 

.13 Other Standards specify whether expenditures are treated as assets or as expenses. These issues are not addressed in this Standard. Accordingly, this Standard neither prohibits nor requires capitalisation of the costs recognised when a provision is made.

 

Definitions

 

.14 The following terms are used in this Standard with the meanings specified:

 

A constructive obligation is an obligation that derives from an entity's actions where:

(a) by an established pattern of past practice, published policies or a sufficiently specific current Standard, the entity has indicated to other parties that it will accept certain responsibilities, and
(b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.

 

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 within the control of the entity.

 

A contingent liability is:

(a) a possible obligation 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 within the control of the entity, or
(b) present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation, or
(ii) the amount of the obligation cannot be measured with sufficient reliability.

 

Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent.

 

A legal obligation is an obligation that derives from:

(a) a contract (through its explicit or implicit terms),
(b) legislation, or
(c) other operation of law.

 

Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits or service potential.

 

An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.

 

An onerous contract is a contract for the exchange of assets or services in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits or service potential expected to be received under it.

 

A provision is a liability of uncertain timing or amount.

 

A restructuring is a programme that is planned and controlled by management, and materially changes either the:

(a) scope of the entity’s activities, or
(b) manner in which those activities are carried out.

 

Provisions and other liabilities

 

.15 Provisions can be distinguished from other liabilities such as payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast:
(a) payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier (and include payments in respect of social benefits where formal agreements for specified amounts exist), and
(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.

 

Accruals are often reported as part of accounts payable, whereas provisions are reported separately.

 

Relationship between provisions and contingent liabilities

 

.16 In a general sense, all provisions are contingent because they are uncertain in timing or amount. However, within this Standard the term "contingent" is used for liabilities and assets that are not recognised because their existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. In addition, the term "contingent liability" is used for liabilities that do not meet the recognition criteria.

 

.17 This Standard distinguishes between:
(a) provisions - which are recognised as liabilities (assuming that a reliable estimate can be made) because they are present obligations and it is probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligations, and
(b) contingent liabilities - which are not recognised as liabilities because they are either:
(i) possible obligations, as it has yet to be confirmed whether the entity has a present obligation that could lead to an outflow of resources embodying economic benefits or service potential, or
(ii) present obligations that do not meet the recognition criteria in this Standard (because either it is not probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made).

 

Recognition

 

Provisions

 

.18 A provision shall be recognised when:
(a) an entity has a present obligation (legal or constructive) as a result of a past event,
(b) it is probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation, and
(c) a reasonable reliable estimate can be made of the amount of the obligation.

 

If these conditions are not met, no provision shall be recognised.

 

Present obligation

 

.19 In some cases it is not clear whether there is a present obligation. In these cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the reporting date.

 

.20 In most cases it will be clear whether a past event has given rise to a present obligation. In other cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation. In such cases, an entity determines whether a present obligation exists at the reporting date by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the reporting date. On the basis of such evidence:
a) where it is more likely than not that a present obligation exists at the reporting date, the entity recognises a provision (if the recognition criteria are met), and
b) where it is more likely that no present obligation exists at the reporting date, the entity discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits or service potential is remote (see paragraph .98).

 

Past event

 

.21 A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the case only:
(a) where the settlement of the obligation can be enforced by law, or
(b) in the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation.

 

.22 Sometimes the actions or representations of the entity's management, or changes in the economic environment, directly influence the reasonable expectations or actions of those outside the entity and, although they have no legal entitlement, they have other sanctions that leave the entity with no realistic alternative to settle certain expenses. Such obligations are sometimes called "constructive obligations". A constructive obligation is one arising from the facts in a particular situation; a legal liability arises from the operation of law (e.g. contract or statutes).

 

.23 Examples of constructive obligations include:
(a) an entity that habitually makes grants-in aid to deserving Communities but is under no legal obligation to do so, but could not change its policy without incurring unacceptable damage to its reputation, and
(b) an entity that has identified contamination in certain land bordering its area of jurisdiction; The  entity may not legally be obliged to clean-up, but because of concern for its community and because of its published policies or past actions it has no realistic alternative but to do so.

 

.24 Financial statements deal with the financial position of an entity at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to continue an entity's ongoing activities in the future. The only liabilities recognised in an entity's statement of financial position are those that exist at the reporting date.

 

.25 Provisions are not made for general operational risks since they do not give rise to present obligations that exist at the reporting date.

 

.26 It is only those obligations arising from past events existing independently of an entity's future actions (that is, the future conduct of its activities) that are recognised as provisions. An example of such obligations is penalties for clean-up costs for unlawful environmental damage imposed by legislation on an entity. These obligations would lead to an outflow of resources embodying economic benefits or service potential in settlement regardless of the future actions of that entity. In contrast, because of legal requirements, pressure from constituents, or a desire to demonstrate community leadership, an entity may intend or need to carry cut expenditure to operate in an particular way in the future. An example would be where an entity decides to fit emission controls on certain of its vehicles. Because the entities can avoid the future expenditure by their future actions, for example, by changing their method of operation: they have no present obligation for that future expenditure and no provision is recognised.

 

.27 An obligation always involves another party to whom the obligation is owed. It is not necessary, however, to know the identity of the party to whom the obligation is owed indeed, the obligation may be to the community at large. Because an obligation always involves a commitment to another party, it follows that a decision by an entity’s management, governing body or council does not give rise to a constructive obligation at the reporting date unless the decision has been communicated before the reporting date to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will discharge its responsibilities.

 

.28 An event that does not give rise to an obligation immediately may do so at a later date, because of changes in the law or because an act (for example, a sufficiently specific public statement) by the entity gives rise to a constructive obligation.

 

.29 Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is virtually certain to be enacted as drafted. For the purpose of this Standard, such an obligation is treated as a legal obligation. However, differences in circumstances surrounding enactment often make it impossible to specify a single event that would make the enactment of a law virtually certain. In many cases, it is not possible to judge whether a proposed new law is virtually certain to be enacted as drafted and any decision about the existence of an obligation should await the enactment of the proposed law.

 

Probable outflow of resources embodying economic benefits or service potential

 

.30 For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits or service potential to settle that obligation. For the purpose of this Standard, an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, that is, the probability that the event will occur is greater than the probability that it will not. Where it is not probable that a present obligation exists, an entity discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits or service potential is remote (see paragraph .98).

 

.31 Where there are a number of similar obligations, the probability that an outflow will be required in settlement is determined by considering the class of obligations as a whole. Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is recognised (if the other recognition criteria are met).

 

Reliable estimate of the obligation

 

.32 The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature are more uncertain than most other assets or liabilities. Except in extremely rare cases, an entity will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is sufficiently reliable to use in recognising a provision.

 

.33 In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability (see paragraph .98).

 

.34 For example, in order to remain cost effective the management of an entity may decide to undertake specified capital expenditure in the future. Such a decision does not, of itself, create an obligation. Another example is where an entity needs to spend substantially on the resurfacing of roads every few years in order to maintain the existing level of service. An obligation would arise only when the resurfacing had been performed and the entity was obliged to pay a third party for the work undertaken.

 

Contingent liabilities

 

.35 An entity shall not recognise a contingent liability.

 

.36 A contingent -liability is disclosed, as required by -paragraph 98, unless the possibility of an outflow of resources embodying economic benefits or service potential is remote.

 

.37 Where an entity is jointly and severally liable for an obligation the part of the obligation that is expected to be met by other parties is treated as a contingent liability. For example, in the case of joint venture debt, that part of the obligation that is to be met by other joint venture participants is treated as a contingent liability. The entity recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits or service potential is probable, except in the rare circumstances where no reliable estimate can be made.

 

.38 Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits or service potential has become probable. If it becomes probable that an outflow of future economic benefits or service potential will be required for an item previously dealt with as a contingent liability, a provision is recognised in the financial statements of the period in which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be made). For example, an entity may have breached an environmental law but it remains unclear whether any damage was caused to the environment. Where, subsequently it becomes clear that damage was caused and remediation will be required, the entity would recognise a provision, because an outflow of economic benefits is now probable.

 

Contingent assets

 

.39 An entity shall not recognise a contingent asset.

 

.40 Contingent assets usually arise from unplanned or other unexpected events that are not wholly within the control of the entity and give rise to the possibility of an inflow of economic benefits or service potential to the entity. An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain.

 

.41 Contingent assets are not recognised in financial statements, since this may result in the recognition of revenue that may never be realised. However, when the realisation of revenue is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.

 

.42 A contingent asset is disclosed, as required by paragraph .103, where an inflow of economic benefits or service potential is probable.

 

.43 Contingent assets are 'assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits or service potential will arise and the asset's value can be measured reliably, the asset and the related revenue are recognized in the financial statements of the period in which the change occurs. If an inflow of economic benefits or service potential has become probable, an entity discloses the contingent asset (see paragraph .103).

 

Measurement

 

Best estimate

 

.44 The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the reporting date.

 

.45 The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the reporting date or to transfer it to a third party at that time. It will often be impossible or prohibitively expensive to settle or transfer an obligation at the reporting date. However, the estimate of the amount that entity would rationally pay to settle or transfer the obligation gives the best estimate of the expenditure required to settle the present obligation at the reporting date.

 

.46 The estimates of outcome and financial effect are determined by the judgement of the management of the entity, supplemented by experience of similar transactions and, in some cases, reports from independent experts. The evidence considered includes any additional evidence provided by events after the reporting date.

 

.47 Uncertainties surrounding the amount to be recognised as a provision are dealt with by various means according to the circumstances. Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. The name for this statistical method of estimation is "expected value". The provision will therefore be different depending on whether the probability of a loss of a given amount is, for example, 60% or 90%. Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range is used.

 

.48 For example, suppose an entity sells goods or performs a service with a warranty under which customers are covered for the cost of repairs of any defects which become apparent within the first six months of purchase. If minor defects are detected in all products sold, repairs costs of R1m would result. If major defects are detected in all products sold repairs costs of R4m would result. The entity’s past experience and future expectations indicate that, for the coming year, 75% of the goods sold will have no defects, 20% of the goods sold will have minor defects and 5% of the goods sold will have major defects. The expected value of the cost of repairs is, R400 000 (that is (75% of nil) + (20% of R1m) + (5% of R4m)).

 

.49 Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes. Where other possible outcomes are either mostly higher or mostly lower than the most likely outcome, the best estimate will be a higher or lower amount. For example, if an entity has to rectify a serious fault in a major plant that it has constructed for a customer, the most likely outcome may be for the repair to succeed at the first attempt at a cost of R1 000, but a provision for a larger amount is made if there is a significant chance that further attempts will be necessary.

 

Risks and uncertainties

 

.50 The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision.

 

.51 Risk describes variability of outcome. A risk adjustment may increase the amount at which a liability is measured. Caution is needed in making judgements under conditions of uncertainty, so that revenue or assets are not overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities. For example, if the projected costs of a particularly adverse outcome are estimated on a prudent basis, that outcome is not then deliberately treated as more probable than is realistically the case. Care is needed to avoid duplicating adjustments for risk and uncertainty with consequent overstatement of a provision.

 

.52 Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph .96(b).

 

Present value

 

.53 Where the effect of time value of money is material, the amount of a provision shall be the present value of the expenditure expected to be required to settle the obligation.

 

.54 Because of the time value of money, provisions relating to cash outflows that arise soon after the reporting date are more onerous than those where cash outflows of the same amount arise later. Provisions are therefore discounted, where the effect is material.

 

.55 When a provision is discounted over a number of years, the present value of the provision will increase each year as the provision comes closer to the expected time of settlement. Paragraph .95(e) of this Standard requires disclosure of the increase during the period in the discounted amount arising from the passage of time.

 

Future events

 

.56 Future events that may affect the amount required to settle an entity's obligation shall be reflected in the amount of a provision where there is sufficient objective evidence that they will occur.

 

.57 Expected future events may be particularly important in measuring provisions. If there is sufficient evidence of likely expected rates of inflation this should be reflected in the amount of the provision. For example, an entity may believe that the cost of clearing up a site at the end of its life will be reduced by future changes in technology. The amount provided for reflects a reasonable expectation of technically qualified, objective observers, taking account of all available evidence as to the technology that will be available at the time of the clean-up. Thus it is appropriate to include, for example, expected cost reductions associated with increased experience in applying existing technology or the expected cost of applying existing technology to a larger or more complex cleanup operation that has previously been carried out. However, the development of a completely new technology for cleaning up unless it is supported by sufficient objective evidence.

 

.58 The effect of possible new legislation which may effect the amount of an existing obligation of an entity is taken into consideration in measuring that obligation when sufficient objective evidence exits that the legislation is virtually certain to be enacted. The variety of circumstances that arise in practice makes it impossible to specify a single event that will provide sufficient, objective evidence in every case. Evidence is required both of what legislation will demand and of whether it is virtually certain to be enacted and implemented in due course. In many cases sufficient objective evidence will not exist until the new legislation is enacted.

 

Expected disposal of assets

 

.59 Gains from the expected disposal of assets shall not be taken into account in measuring a provision.

 

.60 Gains on the expected disposal of assets are not taken into account in measuring a provision, even if the expected disposal is closely linked to the event giving rise to the provision. Instead, an entity recognises gains on expected disposals of assets at the time specified by the Standard of Generally Accepted Municipal Accounting Practice on Property, Plant and Equipment.

 

Reimbursements

 

.61 Where some or all of the expense required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognized when, and only when, if is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognized for the reimbursement should not exceed the amount of the provision.

 

.62 In the statement of financial performance, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.

 

.63 Sometimes an entity is able to look to another party to pay part or all of the expenditure required to settle a provision (for example, through insurance contracts, indemnity clauses or suppliers’ warranties). The other party may either reimburse amounts paid by the entity or pay the amounts directly.

 

.64 In most cases the entity will remain primarily liable for the whole of the amount in question so that the entity would have to settle the full amount if the third party failed to pay for any reason. In this situation a provision is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is recognised when it is virtually certain that reimbursement will be received if the entity settles the liability. However, occasionally the entity will not remain primarily liable for the costs in question so that, if the third party failed to pay, the entity would not be liable. In such a circumstance the entity no longer has a liability for those costs to be met by the third party and the financial statements reflect this fact.

 

.65 In some cases, the entity will not be liable for the costs in question if the third party fails to pay. In such a case, the entity has no liability for those costs and they are not included in the provision.

 

.66 As noted in paragraph .37, an obligation for which an entity is jointly and severally liable is a contingent liability to the extent that it is expected that the obligation will be settled by the other parties.

 

Changes in provisions

 

.67 Provisions shall be reviewed at each reporting rate and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits or service potential will be required to settle the obligation, the provision shall be reversed.

 

.68 Where discounting is used, the carrying amount of a provision increases in each period to reflect the passage of time. This increase is recognised as an interest expense.

 

Use of provisions

 

.69 A provision shall be used only for expenditure for which the provision was originally recognised.

 

.70 Only expenditures that relate to the original provision are set against it. Setting expenditures against a provision that was originally recognised for another purpose would conceal the impact of two different events.

 

Application of the recognition and measurement rules

 

Future operating net deficits

 

.71 Provisions shall not be recognised for net deficits from future operating deficits.

 

.72 Net deficits from future operating activities do not meet the definition of liabilities in paragraph .14 and the general recognition criteria set out for provisions in paragraph .18.

 

.73 An expectation of net deficits from future operating activities is an indication that certain assets used in these activities may be impaired. An entity tests these assets for impairment. Guidance on accounting for impairment is found in the International Accounting Standard on impairment of Assets.

 

Onerous contracts

 

.74 If an entity has a contract that is onerous, the present obligation (net of recoveries) under the contract shall be recognised and measured as a provision.

 

.75 Paragraph .74 of this Standard applies only to contracts that are onerous. Contracts to provide social benefits entered into with the expectation that the entity does not receive consideration that is approximately equal to the value of goods and services provided, directly in return from the recipients of those benefits are excluded from the scope of this Standard.

 

.76 Many contracts evidencing exchange transactions (for example, some routine purchase orders) can be cancelled without paying compensation to the other party, and therefore there is no obligation. Other contracts establish both rights and obligations for each of the contracting parties. Where events make such a contract onerous, the contract falls within the scope of this Standard and a liability exists which is recognised. Executory contracts that are not onerous fall outside the scope of this Standard.

 

.77 This Standard defines an onerous contract as a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits or service potential expected to be received under it which includes amounts recoverable. Therefore, it is the present obligation net of recoveries that is recognised as a provision under paragraph .74. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfill it.

 

.78 Before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract.

 

Restructuring

 

.79 The following are examples of events that may fall under the definition of restructuring:
(a) Sale, termination or the transfer to another government body or council of a service,
(b) The closure of locations where operations are carried on and the relocation of operational activities,
(c) Changes in management structure, for example, eliminating a layer of management, and
(d) Fundamental reorganisations (i.e. those that have a material effect on the nature and focus of the entity's operations.

 

.80 provision for restructuring costs is recognised only when the general recognition criteria for provisions set out in paragraph .18 are met. Paragraphs .81 to .94 set out how the general recognition criteria apply to restructurings.

 

.81 A constructive obligation to restructure arises only when an entity:
(a) has a detailed formal plan for the restructuring identifying at least:
(i) the activity/operating unit or part of an activity/operating unit concerned,
(ii) the principal locations affected,
(iii) the location, function, and approximate number of employees who will be compensated for determining their services,
(iv) the expenditures that will be undertaken, and
(v) when the plan will be implemented.
(b) has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.

 

.82 A public announcement by itself would not constitute a commitment unless it obliges the entity to pay out resources or dispose of assets. A commitment only arises if the announcement is made in such a way and in sufficient detail for other parties, such as customers or suppliers, to be expected to act on the basis that the reorganisation will proceed and, in so doing, remove the realistic possibility of the entity withdrawing. The announcement would normally specify the service operations or part of a service operation that is affected, the locations in question, the total number of employees affected and the total costs, and indicate the timing of the reorganisation. Communication of the plan to employees would have to be made at a reasonable level of detail to staff involved or their representatives. The effect of the communication must be such that withdrawal by the entity is not realistic in view of the damage it would cause to relationships with employees and the community in which the entity operates and the fact that some employees will have found other jobs.

 

.83 Examples of implementation include dismantling plant, selling assets, notifying external parties (such as notifying ratepayers that services will be discontinued) and communication to employees.

 

.84 For a plan to be sufficient to give rise to a constructive obligation when communicated to those affected by it, its implementation needs to be planned to begin as soon as possible and to be completed in a timeframe that makes significant changes to the plan unlikely. If it is expected that there will be a long delay before the restructuring begins or that the restructuring will take an unreasonably long time, it is unlikely that the plan will raise a valid expectation on the part of others that the entity is at present committed to restructuring, because the timeframe allows opportunities for the entity to change its plans.

 

.85 A decision by the council or the governing body to restructure taken before the reporting date does not give rise to a constructive obligation at the reporting date unless the entity has, before the reporting date:
(a) started to implement the restructuring plan, or
(b) announced the main features of the restructuring plan to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will carry out the restructuring.

 

In some cases, an entity starts to implement a restructuring plan, or announces its main features to those affected, only after the reporting date. Disclosure may be required under the International Public Sector Accounting Standard on Events After the Reporting Date, if the restructuring is of such importance that its non-disclosure would affect the ability of the users of the financial statements to make proper evaluations and decisions.

 

.86 Although a constructive obligation is not created solely by council or governing body decision, an obligation may result from other earlier events together with such a decision. For example, negotiations with employee representatives for termination payments, or with purchasers for the sale or transfer of an operation, may have been concluded subject only to governing body or council approval. Once that approval has been obtained and communicated to the other parties, the entity has a constructive obligation to restructure, if the conditions of paragraph .81 are met.

 

.87 The ultimate authority for decision making about an entity is vested in a governing body or council whose membership includes representatives of interests other than those of management (e.g. employees) or notification to these representatives may be necessary before the governing body or council decision is taken. Because a decision by such a governing body or council involves communication to these representatives, it may result in a constructive obligation.

 

Sale and transfer of operations

 

.88 No obligation arises as a consequence of the sale and transfer of an operation until the entity is committed to the sale or transfer, that is, there is a binding agreement.

 

.89 Even when an entity has taken a decision to sell an operation and announced that decision publicly, it cannot be committed to the sale until a purchaser has been identified and there is a binding sale agreement. Until there is a binding agreement, the entity will be able to change its mind and indeed will have to take another course of action if a purchaser cannot be found on acceptable terms. When a sale is only part of a restructuring, a constructive obligation can arise for the other parts of the restructuring before a binding sale agreement exists.

 

.90 Restructuring within the public sector often involves the transfer of operations from one controlled entity to another and may involve the transfer of operations at no or nominal consideration. Such transfers will often take place under a government directive and will not involve binding agreements as described in paragraph .89. An obligation exists only when there is a binding agreement. Even where proposed transfers do not lead to the recognition of a provision, the planned transaction may require disclosure under other Standards of Generally Accepted Municipal Accounting Practice or International Public Sector Accounting Standards or Statements of Generally Accepted Accounting Practice, such as the International Public Sector Accounting Standard on Events After the Reporting Date.

 

Restructuring Provisions

 

.91 A restructuring provision shall include only the direct expenditure arising from restructuring, which are those that are both:
(a) necessarily entailed by a restructuring, and
(b) not associated with the ongoing activities of the entity.

 

.92 A restructuring provision does not include such costs as:
(a) retraining or relocating continuing staff,
(b) marketing, and
(c) investment in new systems and distribution networks.

 

These expenditure relate to the future conduct of an activity and are not liabilities for restructuring at the reporting date. Such expenditures are recognised on the same basis as if they arose independently of a restructuring.

 

.93 Identifiable future operating net deficits up to the date of a restructuring are not included in a provision, unless they relate to an onerous contract as defined in paragraph .14.

 

.94 As required by paragraph .59, gains on the expected disposal of assets are not taken into account in measuring a restructuring provision, even if the sale of assets is envisaged as part of the restructuring.

 

Disclosure

 

.95 For each class of provision, an entity shall disclose:
(a) The carrying amount at the beginning and end of the period,
(b) Additional provisions made in the period, including increases to existing
(c) Amounts used (that is, ineurred and charged against the provision)
(d) Unused amounts reversed during the period, and
(e) The increase during the period in the discounted amount arising from the provisions, during the period, passage of time and the effect of any change in the discount rate.

 

Comparative information is not required.

 

.96 An entity shall disclose the following for each class of provision:
(a) A brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits or service potential,
(b) An indication of the uncertainties about the amount or timing of those outflows. Where necessary to provide adequate information, an entity shall disclose the major assumptions made concerning future events, as addressed in paragraph .56, and
(c) The amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.

 

.97 Where an entity elects to recognise in its financial statements provisions for social benefits for which it does not receive consideration that is approximately equal to the value of goods and services provided, directly in return from the recipients of those benefits, it shall make the disclosures required in paragraphs .95 and .96 in respect of those provisions.

 

.98 Unless the possibility of any outflow in settlement is remote, an entity shall disclose for each class of contingent liability at the reporting date a brief description of the nature of the contingent liability and, where practicable:
(a) an estimate of its financial effect, measured under paragraphs .44 to .60,
(b) an indication of the uncertainties relating to the amount or timing of any outflow, and
(c) the possibility of any reimbursement.

 

.99 In determining which provisions or contingent liabilities may be aggregated to form a class, it is necessary to consider whether the nature of the items is sufficiently similar for a single Standard about them to fulfill the requirements of paragraphs .96(a) and (b) and .98(a) and (b). Thus, it may be appropriate to treat as a single class of provision amounts relating to one type of obligation, but it would not be appropriate to treat as a single class amounts relating to environmental restoration costs and amounts that are subject to legal proceedings.

 

.100 Where a provision and a contingent liability arise from the same set of circumstances, an entity makes the disclosures required by paragraphs .95, .96 and .98 in a way that shows the link between the provision and the contingent liability.

 

.101 An entity may in certain circumstances use external valuation to measure a provision. In such cases, information relating to the valuation can usefully be disclosed.

 

.102 The disclosure requirements in paragraph .98 do not apply to contingent liabilities that arise from social benefits provided by an entity for which it does not receive consideration that is approximately equal to the value of goods or services provided, directly in return from the recipients of those benefits (see paragraphs .01(a) and .04 to .08 for a discussion of the exclusion of social benefits from this Standard).

 

.103 Where an inflow of economic benefits or service potential is probable, an entity shall disclose a brief description of the nature of the contingent assets at the reporting date, and, where practicable, an estimate of their financial effect, measured using the principles set out for provisions in paragraphs .44 to .60.

 

.104 The disclosure requirements in paragraph .I03 are only intended to apply to those contingent assets where there is a reasonable expectation that benefits will flow to the entity. That is, there is no requirement to disclose this information about all contingent assets (see paragraphs .39 to .43 for a discussion of contingent assets). It is important that disclosures for contingent assets avoid giving misleading indications of the likelihood of revenue arising. For example, a contingent asset would arise from a contract where an entity allows a private sector company to mine one of its properties in exchange for a royalty based on a set price per ton extracted and the company has commenced mining. In addition to disclosing the nature of the arrangement, the contingent asset should be quantified where a reasonable estimate can be made of the quantity of mineral to be extracted and the timing of the expected cash inflows. If there were no proven reserves or some other circumstances prevailed that indicated that it would be unlikely that any minerals would be extracted, the entity would not disclose information required by paragraph .103 as there is no probable flow of benefits.

 

.105 Where any of the information required by paragraphs .98 and .103 is not disclosed because it is not practicable to do so, that fact shall be stated.

 

.106 In extremely rare cases, disclosure of some or all of the information required by paragraph .95 to .104 can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the provision, contingent liability or contingent assets. In such cases, an entity 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.

 

Effective date

 

.107 This Standard of Generally Accepted Municipal Accounting Practice becomes effective for annual financial statements covering periods beginning on or after a date to be determined by the Minister of Finance in a regulation to be published in accordance with section 91(1)(b) of the Public Finance Management Act, Act No. 1 of 1999 as amended.