Plain vanilla liabilities are usually accounted for at amortized cost, but IAS 39 provides an option to measure at fair value under restricted conditions where they are matching assets valued at fair value (see section on financial instruments above). The standard that addresses non-financial liabilities is IAS 37, currently labelled Provisions, Contingent Liabilities and Contingent Assets and currently the subject of proposed amendments.

Leaving aside contingent items for the time being, the basic principle of the standard is (IAS 37.14):

A provision shall be recognized 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 will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.

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

Applying the standard calls for a high degree of judgement

Applying the standard calls for a high degree of judgement. The first issue is whether an obligation exists. The requirement for there to be an obligation can be seen as an anti-abuse measure that is designed to limit the practice of creating unnecessary provisions in good times to release them later (known as ‘cookie jar provisions’ in the US literature) as part of an earnings management process.

The standard itself (IAS 37.70–83) goes into detail about the point at which an entity may conclude ...

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