Comments from ACCA to The Auditing Practices Board, April 2010.
ACCA is pleased to comment on the exposure draft (ED) on the above subject, which was considered by ACCA’s Financial Reporting Committee.
We understand that two of the main aims for undertaking this project are to remove the inconsistencies for recognising liabilities with those in other standards such as IFRS3 and IAS39 and to clarify the measurement requirements in IAS37 itself. As we stated in our response to the original exposure draft of proposed amendments to IAS37 in 2005, we believe that while there are some flaws in the existing version of IAS37 we are not aware the measurement guidance is a significant issue for preparers or that it does not provide decision-useful information for users. In previous comments submitted to the Board, we have also raised concerns about ensuring amendments to standards provide a meaningful improvement to the existing IFRS, and that there should be a tangible benefit to users and preparers. We do not believe that this is the case for the overall amendments to IAS37.
We also note that the original exposure draft was issued nearly five years ago, and that like ACCA, many constituents had significant reservations about the proposals, especially in relation to the measurement requirements. Since that period many new constituents have been applying IFRS and will not have had the opportunity to comment on the original proposals, which are likely to have a major change to current practice. As such, we do not agree with the Board’s decision to only seek comments on the expanded measurement requirements. We believe a full exposure of the proposed new standard would have been more appropriate.
Furthermore, we do not believe that the rationale for making the changes is extensive enough. This change in measurement represents a conceptual change which should be considered by a more extensive due process, and supported by appropriate field-testing to support the decision.
As such, we do not support the measurement model proposed in the ED and do not believe that the Board should pursue this project, especially given the other priorities which the Board has. We have however, provided comments on the specific questions raised in the ED, in order to facilitate the Board’s due process.
Question 1: Overall requirements
The proposed measurement requirements are set out in paragraphs 36A-36F. Paragraphs BC2-BC11 of the accompanying Basis for Conclusions explain the Board’s reasons for these proposals.
Do you support the requirements proposed in paragraphs 36A-36F? If not, with which paragraphs do you disagree and why?
We acknowledge that the revised guidance does clarify the new recognition criteria regarding what constitutes obligating events. However, we would reiterate that the existing measurement criteria based on the expected outflow to settle a liability provide a better discriminator for providing full information about a liability. The proposals would tend to require similar treatment for liabilities that are almost certain and for those with perhaps a very low probability of occurrence even if the potential payout is large. While using probability weighting would be appropriate for a portfolio of similar liabilities, where historical experience can be used to form a reasonable expectation, this is clearly not the case for single liabilities.
In cases where the assessment of outcomes is very subjective it does not seem to add useful information simply to incorporate these very uncertain numbers in the balance sheet and profit and loss account rather than disclose comparable information in the notes. There may be some risk that the existing note disclosure explaining the contingent liabilities could be reduced in quality when the possible liability is provided for in the balance sheet.
We therefore do not support the requirements in paragraphs 36B and B8 for measuring all such non-financial liabilities. These requirements are more akin to a fair value measurement rather than a measurement of the expected outflows likely to settle the liability itself. While this would appear relevant in the context of a business combination for example, we do not believe that it provides decision-useful information in all other cases.
Question 2: Obligations fulfilled by undertaking services
Some obligations within the scope of IAS 37 will be fulfilled by undertaking a service at a future date. Paragraph B8 of Appendix B specifies how entities should measure the future outflows required to fulfil such obligations. It proposes that the relevant outflows are the amounts that the entity would rationally pay a contractor at a future date to undertake the service on its behalf.
Paragraphs BC19-BC22 of the Basis for Conclusions explain the Board’s rationale for this proposal.
Do you support the proposal in paragraph B8? If not, why not?
We do not support the proposal in paragraph B8 on the same basis as the views expressed in the alternative views in paragraph AV2. Not only is the inclusion of an explicit profit margin in the amount an entity would pay a third party, a hypothetical amount that would not be an actual outflow, it would also result in a reduction in profit on inception, which would in turn be reflected when the liability is derecognised. We agree with the alternative views that this does not provide decision-useful information.
We also note that the ED includes a requirement (paragraphs B15 – B17) to include a risk adjustment to measure the present value of the resources required to fulfil an obligation. Again, as expressed in the alternative views (paragraphs AV5 – 6), there does appear to be some ambiguity over the inclusion of this in the measurement of a liability. If an entity is performing an assessment of the probability of each possible outcome to determine the expected value, then a risk adjustment would therefore represent ‘an additional profit margin’ on top of the expected value.
Question 3: Exception for onerous sales contracts
Paragraph B9 of Appendix B proposes a limited exception for onerous contracts arising from transactions within the scope of IAS 18 Revenue and IFRS 4 Insurance Contracts. The relevant future outflows would be the costs the entity expects to incur to fulfil its contractual obligations rather than the amounts the entity would pay a contractor to supply them on its behalf.
Paragraphs BC23-BC27 of the Basis for Conclusion explain the reason for this exception.
Do you support the exception? If not, what would you propose instead?
We agree with the proposed measurement for onerous contracts and to include an exception for such contracts arising from transactions within the scope of IAS18 and IFRS4. We agree that it is not practical to introduce a change in requirements for practitioners that could be potentially reversed when these standards are replaced. Indeed, we would also note that the inclusion of an explicit profit margin (as considered in Question 2) could establish a principle for these future standards also.