Year-End Provisions - Compliance with IAS 37 and Accounting for Employee Benefits under IAS 19
Introduction
The end of the financial year requires businesses to make provisions for obligations, expenses, and potential liabilities that may arise in the future. Properly accounting for these provisions ensures transparency, meets compliance requirements, and reflects an accurate financial position. This article covers the key provisions under IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets) and addresses leave pay provisions and employee benefits in terms of IAS 19 (Employee Benefits).
1. Understanding Provisions in the Context of IAS 37
IAS 37 provides guidance on recognising and measuring provisions, contingent liabilities, and contingent assets. This standard aims to ensure provisions are recognised when there is a present obligation resulting from past events, probable outflows of resources, and a reliable estimate can be made of the obligation.
Key Criteria for Recognising Provisions
Present Obligation: A provision is recognised if there is a present obligation, either legal or constructive, due to a past event.
Probable Outflow: There must be a likelihood of an outflow of resources to settle the obligation.
Reliable Estimate: A provision can only be recognised if a reliable estimate of the obligation can be made.
Examples of Common Year-End Provisions under IAS 37
Provision for legal disputes or claims
Environmental obligations or restructuring costs
Onerous contracts where unavoidable costs exceed economic benefits
An onerous contract is a contract in which the costs to fulfil the contract exceed the economic benefits expected to be received from it. In simpler terms, it’s a contract where the unavoidable costs of meeting the obligations under the contract are higher than the revenue or benefit that the contract will bring.
Under IAS 37, an entity must recognize a provision for an onerous contract when it becomes apparent that the contract will result in a loss. The provision amount should equal the lower of:
The cost of fulfilling the contract (e.g., costs of materials, labour, and other expenses directly related to the contract), or
The penalties or compensation payments for failing to fulfil the contract.
Example of an Onerous Contract
Imagine a company has signed a contract to deliver products at a fixed price of R100,000. Due to unexpected price increases in materials, the total cost to fulfil this contract has risen to R120,000. Here, the contract has become onerous, as the costs (R120,000) are greater than the economic benefit (R100,000).
Assume a company expects a probable cash outflow of R50,000 related to a legal claim.
Year-End entry to recognise provision:
Dr Legal Expenses R50,000
Cr Provision for Legal Claim R50,000
Adjustment in the Following Period (if revised to R40,000):
Dr Provision for Legal Claim R10,000
Cr Legal Expenses R10,000
This adjustment updates the provision based on the latest reliable estimate.
2. Year-End Leave Pay Provisions
One critical year-end provision is leave pay, where employers must account for employee leave entitlements. Unused leave accumulated by employees represents a liability for the company, which should be accounted for based on the guidance in IAS 37.
Calculating Leave Pay Provisions
Determine Accrued Leave: Calculate each employee’s accrued leave days at year-end.
Value of Leave Days: Multiply the accrued leave days by the employee’s daily wage rate.
Discounting: While short-term leave may not require discounting, long-term leave obligations (e.g., sabbatical leave) may need to be discounted to present value.
Recognising the Provision
This provision reflects the company’s obligation to pay employees for unused leave, ensuring that financial statements fairly present the liabilities tied to employee entitlements. Leave pay provisions align with IAS 37 as they are a present obligation from past services and are reliably measurable.
2. Year-End Leave Pay Provisions under IAS 37
Leave pay provisions account for unused leave days accrued by employees, representing a liability.
Journal Entry Example for Leave Pay Provision
If an employee has accrued 10 leave days at a daily rate of R200, the total provision is R2,000.
Year-End Entry to recognise leave pay provision:
Dr Employee Benefits Expense R2,000
Cr Provision for Leave Pay R2,000
When leave is taken (next period):
Dr Provision for Leave Pay R2,000
Cr Cash/Bank R2,000
This entry reflects the reduction in the provision when the leave is paid out.
3. Employee Benefits in compliance with IAS 19
IAS 19 outlines accounting for employee benefits, which fall into four main categories:
Short-term benefits (e.g., wages, bonuses, leave pay)
Post-employment benefits (e.g., pensions, retirement benefits)
Other long-term benefits (e.g., long-service leave, disability benefits)
Termination benefits
For year-end financial reporting, IAS 19 emphasises that the obligations for these benefits should be accurately recorded and disclosed.
Short-Term Employee Benefits
These are benefits due to employees within 12 months of the period in which the employee renders service. Leave pay, as discussed, is an example, as is any unpaid bonus due at year-end. These short-term benefits are recognised at an undiscounted amount under IAS 19, as they do not require discounting due to their short-term nature.
Post-Employment Benefits and Actuarial Valuations
Post-employment benefits, such as pension plans or medical aid for retirees, require actuarial valuations to determine the present value of future obligations. IAS 19 requires that the actuarial assumptions used (such as life expectancy, salary growth, and discount rates) be consistent and appropriate to the entity’s specific context.
Short-Term Employee Benefits Journal Entry Example
For accrued wages, let’s say R10,000 is unpaid at year-end:
Year-End Entry to Recognise Accrued Wages:
Dr Employee Benefits Expense R10,000
Cr Accrued Wages Payable R10,000
When Wages are Paid:
Dr Accrued Wages Payable R10,000
Cr Cash/Bank R10,000
Post-Employment Benefits (Pension Obligations) Journal Entry Example under IAS 19
Assume a defined benefit obligation valued at R500,000 after actuarial assessment, and pension fund assets valued at R450,000, resulting in a net liability of R50,000.
Initial Recognition of Defined Benefit Obligation:
Dr Employee Benefits Expense R500,000
Cr Defined Benefit Obligation R500,000
To Record Fair Value of Plan Assets:
Dr Plan Assets R450,000
Cr Employee Benefits Expense R450,000
To Recognise the Net Liability:
Dr Employee Benefits Expense R50,000
Cr Pension Liability R50,000
This entry records the net liability due to the underfunded pension plan.
Actuarial Gains and Losses
If there is an actuarial gain of R10,000, IAS 19 requires recognition in other comprehensive income (OCI):
To Record Actuarial Gain:
Dr Defined Benefit Obligation R10,000
Cr Other Comprehensive Income (OCI) R10,000
This entry reflects the remeasurement of the defined benefit obligation in OCI.
5. Practical Steps for Year-End Provision Compliance
Step 1: Review Contracts and Legal Obligations
Identify any legal or constructive obligations by reviewing outstanding contracts and agreements with employees to determine what provisions may be required.
A constructive obligation is an obligation that arises from an entity's actions, rather than from a legally enforceable contract or law. Specifically, it’s created when an entity, through its established practices, published policies, or specific statements, has indicated to others that it will accept certain responsibilities, and as a result, it creates a valid expectation in those parties that the entity will fulfil those responsibilities.
Under IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets), a constructive obligation is recognized as a provision if it meets the following criteria:
There is a present obligation (legal or constructive) resulting from a past event.
It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation.
The amount of the obligation can be reliably estimated.
Example of a Constructive Obligation
Suppose a company has a longstanding practice of providing refunds to dissatisfied customers, even though it is not legally required to do so. Over time, customers come to expect that the company will issue refunds in certain situations. The company may then have a constructive obligation to provide refunds, based on the expectation it has set through its behaviour.
In this case, the company may need to recognize a provision in its financial statements to cover potential refunds, as it has created a constructive obligation through its consistent actions
Step 2: Calculate Accurate Leave Pay and Benefit Provisions
Ensure that you’ve calculated accrued leave and other entitlements, applying discounting where necessary for long-term benefits.
Step 3: Document Actuarial Assumptions and Methods
For post-employment benefits, document all actuarial assumptions, and ensure they are reviewed by a qualified actuary where necessary. For example, discount rates should reflect market yields on high-quality corporate bonds with similar maturity terms.
Step 4: Disclosure and Reporting
IAS 37 and IAS 19 require specific disclosures about provisions, including:
The nature of the obligation
Expected timing of outflows
Any uncertainties associated with timing or amount
Reconciliation of changes in provisions over the reporting period
Conclusion
Accurate year-end provisions for leave pay and employee benefits in line with IAS 37 and IAS 19 strengthen financial statement reliability and demonstrate commitment to employee obligations. This compliance reflects well on corporate transparency and financial management. Year-end provisions play an essential role in ensuring financial statements accurately reflect a company’s liabilities. Compliance with IAS 37 and IAS 19 is critical for recognising, measuring, and disclosing provisions for obligations, including leave pay and employee benefits. Ensuring adherence to these standards fosters transparency, reduces financial risk, and provides stakeholders with reliable financial information.