This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to Henry Rees, Project Manager at International Accounting Standards Board on 2 November, 2005:
Dear Mr. Rees,
Proposed Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, and IAS 19 Employee Benefits
We appreciate the opportunity to comment on the proposals of the International Accounting Standards Board (“IASB”) to amend the above accounting standards.
We support the IASB’s efforts to converge accounting standards internationally and its aim of promoting high quality accounting standards. However, we do not support the proposals for fundamental changes to the existing current accounting model.
We are concerned that the IASB is seeking to introduce radical new accounting requirements at a time when many entities worldwide are adopting IFRS for the first time and are making associated significant changes to their accounting. It is unfortunate that the IASB should seek to make such changes to accounting requirements at this point. The international financial markets need stability of financial reporting and we are strongly of the view that where (as is the case with the existing IAS 37) an accounting standard gives high quality financial information and is not significantly flawed, it should not be changed to introduce new requirements that some (but by no means all) might regard as being technically superior.
We do not consider that the existing IAS 37 contains any fundamental flaws that require the immediate attention of the IASB. While there are aspects where clarification would be helpful, such as certain interactions between IAS 37 and IAS 19 that are addressed in the exposure draft, and other interactions with (for example) IAS 18 and accounting for warranties which are not addressed in the exposure draft, in our view there is no need for a comprehensive change at this stage.
We note that the IASB has other projects covering Liabilities and Equity, and Revenue, and consider that it would be more appropriate to leave the proposed amendments to IAS 37 for the moment, and link any changes that might be found necessary to the outcome of those other projects.
With regard to the exposure draft itself, we disagree in particular with the proposals to recognise on the balance sheet, items that are currently termed contingent liabilities. This would result in entities initially recognising liabilities on the balance sheet at amounts which are guaranteed to be different from the amounts at which they will eventually be settled. We do not believe that this form of disclosure and measurement is useful to users of financial statements, nor do we believe that it would improve the quality of financial reporting.
Some have suggested that there is an inconsistency between the current IFRS 3 and IAS 37, as IFRS 3 requires the recognition of contingent liabilities on a business combination, while IAS 37 otherwise prohibits such recognition. We do not believe that this is a significant concern. As noted in the Basis for Conclusions to IFRS 3, the requirement for recognition of contingent liabilities on a business combination was introduced as a result of that standard’s proposals for negative goodwill and the consequent risk of credits appearing in the consolidated income statement where an entity with significant contingent liabilities was acquired. In our view, that is a practical solution to an issue that was properly anticipated by the IASB when IFRS 3 was published.
Our responses to your specific questions are set out in the Appendix to this letter.
We would be pleased to discuss our comments and observations with you further if this would be helpful.
Yours sincerely,
Helen Thomson
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Appendix
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Question 1 – Scope of IAS 37 and terminology
(a) Do you agree that IAS 37 should be applied in accounting for all non-financial liabilities that are not within the scope of other Standards? If not, for which type of liabilities do you regard its requirements as inappropriate and why?
(b) Do you agree with not using ‘provision’ as a defined term? If not, why not?
We agree that a standard is required to capture liabilities not within the scope of other standards.
We believe the term non-financial liability is misleading and confusing. Many of the liabilities within the scope of the revised IAS 37 may be required to be settled in cash, as for financial liabilities within the scope of IAS 32. We believe it would be preferable to retain the term “provision” and the IASB seems to accept this, as it notes the term may still be used in financial statements.
Question 2 – Contingent liabilities
(a) Do you agree with eliminating the term ‘contingent liability’? If not, why not?
(b) Do you agree that when the amount that will be required to settle a liability (unconditional obligation) is contingent on the occurrence or non-occurrence of one or more uncertain future events, the liability should be recognised independently of the probability that the uncertain future event(s) will occur (or fail to occur)? If not, why not?
While we can see some conceptual merit in the proposed approach, it appears confusing and it is likely to give rise to problems on implementation in practice. To illustrate this point, the examples of a disputed lawsuit and a potential lawsuit in the Illustrative Examples are confusing. In particular, it is not clear whether it is the occurrence of the event giving rise to the claim, the acknowledgement of liability, or the start of legal proceedings that constitutes a past event.
Question 3 – Contingent assets
(a) Do you agree with eliminating the term ‘contingent asset’? If not, why not?
(b) Do you agree that items previously described as contingent assets that satisfy the definition of an asset should be within the scope of IAS 38? If not, why not?
It is not clear why an amount that might be recovered in a court case should be classed as intangible asset. We consider that the classification of such an item as a contingent asset is a better description of what the asset represents and is more easily understood by users of financial statements.
We do not believe that contingent assets should fall within the scope of IAS 38. In particular, many contingent assets will be settled in cash (such as damages received through a court case) and therefore are not intangible assets, as they are not non-monetary.
Question 4 – Constructive obligations
(a) Do you agree with the proposed amendment to the definition of a constructive obligation? If not, why not? How would you define one and why?
(b) Is the additional guidance for determining whether an entity has incurred a constructive obligation appropriate and helpful? If not, why not? Is it sufficient? If not, what other guidance should be provided?
We are not convinced that the proposed change adds clarity, nor that “reasonably rely” might be regarded as being a particularly stronger test than that set out in existing guidance.
Question 5 – Probability recognition criterion
Do you agree with the analysis of the probability recognition criterion and, therefore, with the reasons for omitting it from the Standard? If not, how would you apply the probability recognition criterion to examples such as product warranties, written options and other unconditional obligations that incorporate conditional obligations?
We do not agree with the proposal. It is inappropriate for an accounting standard to be amended in a way that results in it being inconsistent with the Framework.
We are not convinced that the fundamental shift envisaged is necessary or that the costs involved justify the benefits.
For warranties and other similar items where the reporting entity has a large population of items, probability is reflected in measurement under paragraph 24.
Question 6 – Measurement
Do you agree with the proposed amendments to the measurement requirements? If not, why not? What measurement would you propose and why?
We are not convinced that the approach suggested is suitable for single obligations or small populations. The assumption that simply applying probabilities will give an amount at which a third party will buy the liability is unproven. In many cases, no such third party exists.
What is certain is that, by applying an expected cash flow basis to single items, the amount recorded will not equal the eventual cash flow. As such, its usefulness, relevance and reliability would appear questionable.
We consider that the “most likely” approach set out in the existing IAS 37 should be retained.
As an example, if a claim has a 90% probability of being settled for Euro 10 and a 10% probability of being settled for Euro 100, the probability weighted expected value is Euro 19, an amount that isn't even a possible outcome. Why is Euro 19 a useful measurement? It might be argued that it is useful because it is the best estimate of how much the entity would pay a third party to assume its obligation. However, because for most of these liabilities there is no such third party, we question the usefulness of the measurement. A liability of Euro 10, representing the likeliest outcome, with disclosure of the exposure to an additional loss of Euro 90, would appear more informative and more transparent. This approach would also be less vulnerable to manipulation by changing the subjective probabilities.
In addition, there is no guidance in the exposure draft as to whether, when discounting a liability, the discount rate should reflect the obligated entity's credit risk. This is a major issue and we believe that guidance should be included.
Question 7 – Reimbursements
Do you agree with the proposed amendment to the recognition requirements for reimbursements? If not, why not? What recognition requirements would you propose and why?
We agree.
Question 8 – Onerous contracts
(a) Do you agree with the proposed amendment that a liability for a contract that becomes onerous as a result of the entity’s own actions should be recognised only when the entity has taken that action? If not, when should it be recognised and why?
(b) Do you agree with the additional guidance for clarifying the measurement of a liability for an onerous operating lease? If not, why not? How would you measure the liability?
(c) If you do not agree, would you be prepared to accept the amendments to achieve convergence?
We find the guidance in paragraph 57 confusing. If an entity is the lessee in an operating lease, for a property where the required rentals now exceed the economic benefit from using the leased property, then that would appear to be an onerous contract. How is the liability measured? The entity can continue to use the property or it can cease using the property and attempt to sublease it. We believe that under the proposals (although it is not entirely clear), the liability would be measured at the lower of the two potential amounts arising from either continued use or cessation of use and subleasing (the least net cost). However, if the smaller loss amount is the loss arising from ceasing to use and subleasing, ceasing use is an event in the entity's control. The proposals note that if the event is in the entity's control, then a liability should not be recorded until the entity takes the necessary action (paragraph 57). We presume that events in the entity's control can be used to reduce a liability even if the entity has not taken the action (paragraph 58).
Question 9 – Restructuring provisions
(a) Do you agree that a liability for each cost associated with a restructuring should be recognised when the entity has a liability for that cost, in contrast to the current approach of recognising at a specified point a single liability for all of the costs associated with the restructuring? If not, why not?
(b) Is the guidance for applying the Standard’s principles to costs associated with a restructuring appropriate? If not, why not? Is it sufficient? If not, what other guidance should be added?
We do not agree with the proposal. It is questionable whether disaggregating and “delaying” recognition of certain costs associated with a committed restructuring results in a presentation that is beneficial to the users of the accounts.
IAS 19 Employee Benefits
Question 1 – Definition of termination benefits
The Exposure Draft proposes amending the definition of termination benefits to clarify that benefits that are offered in exchange for an employee’s decision to accept voluntary termination of employment are termination benefits only if they are offered for a short period (see paragraph 7). Other employee benefits that are offered to encourage employees to leave service before normal retirement date are post-employment benefits (see paragraph 135).
Do you agree with this amendment? If not, how would you characterise such benefits, and why?
Question 2 – Recognition of termination benefits
The Exposure Draft proposes that voluntary termination benefits should be recognised when employees accept the entity’s offer of those benefits (see paragraph 137). It also proposes that involuntary termination benefits, with the exception of those provided in exchange for employees’ future services, should be recognised when the entity has communicated its plan of termination to the affected employees and the plan meets specified criteria (see paragraph 138).
Is recognition of a liability for voluntary and involuntary termination benefits at these points appropriate? If not, when should they be recognised and why?
Question 3 – Recognition of involuntary termination benefits that relate to future service
The Exposure Draft proposes that if involuntary termination benefits are provided in exchange for employees’ future services, the liability for those benefits should be recognised over the period of the future service (see paragraph 139). The Exposure Draft proposes three criteria for determining whether involuntary termination benefits are provided in exchange for future services (see paragraph 140).
Do you agree with the criteria for determining whether involuntary termination benefits are provided in exchange for future services? If not, why not and what criteria would you propose? In these cases, is recognition of a liability over the future service period appropriate? If not, when should it be recognised and why?
We are generally in agreement with the IAS 19 revisions.
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Exposure Drafts, Comments due 28 October 2005: