LOOK BEFORE YOU LEAP: VALIDATING IAS 37 PROVISIONS FOR POTENTIAL LIABILITIES USING OPTION THEORY
International Accounting Standards (IAS) Rule 37 regarding ‘Provisions for Contingent Liabilities and Contingent Assets’ was designed to make analysis of exposures facing a corporate entity easier to understand but, according to detractors, the rules are insufficiently prescriptive. Under IAS 37, specific criteria are provided so that appropriate recognition criteria and measurement bases are applied to the provisioning of contingent liabilities and contingent assets.
First introduced in 1999 with amendments in 2005 and 2020, the objective of IAS 37 is to ensure that financial analysts, investors, regulators and other stakeholders understand the potential risks and liabilities a firm may be facing. According to critics, under the rules, ensuring the adequacy of provisions for potential risks like uncollectable debt, lawsuits or warranty recalls and their liabilities remains complicated, often leading to disputes.
Notwithstanding further prescriptive changes to the rules, concerns over the adequacy of provisions and the magnitude of exposures persist, especially as over-provisioning may create scope for management and smoothing of earnings. Hoping that ‘experts’ can attach an objective probability to a warranty recall may not be realistic. Might there be a better way? The shortcomings of IAS 37 raise the questions of whether there is an objective means of validating the magnitude of provisions, and whether they are appropriate to the risks and potential liabilities a firm may face.
Apr-Jun 2023 issue
The University of Brighton