Future operating losses Natural disasters – Miscellaneous considerations
Entities may incur other losses directly or indirectly related to a natural disaster. An entity may anticipate having future operating losses for a period of time after a natural disaster. For example, an entity may have repair costs, lost revenue due to plant closures or losses due to an overall decline in the economy. Additional costs might be incurred in renting alternative production facilities, providing transport or accommodation for employees or outsourcing business functions.
Future operating losses and costs do not meet the definition of a liability (because they do not arise from a present obligation resulting of a past event), and therefore are not recognised until incurred.
A contract is considered onerous when the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it. The present obligation under an onerous contract is recognised and measured as a provision. For example, when a manufacturing entity has contracts to sell goods at a fixed price and, because of the natural disaster, it cannot deliver the goods itself without procuring them from a third party, the provision for the onerous contract will reflect the lower of the penalty for terminating the contract or the present value of the net cost of fulfilling the contract (i.e., the excess of the cost to procure the goods over the consideration to be received).
When a natural disaster has occurred, contracts should be reviewed to determine if there are any special terms that may relieve an entity of its obligations (e.g., force majeure). Finally, before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract.
Constructive obligations Natural disasters – Miscellaneous considerations
Additional non-legal obligations may arise as a result of a natural disaster. For example, an entity with no previous environmental obligations may establish a constructive obligation that it will repair environmental damage as a result of the disaster. Such a constructive obligation will only result in the recognition of a provision if by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities and as a result, it has created a valid expectation on the part of those other parties that it will discharge those responsibilities.
The general recognition requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets would have to be met. That is, there is a present obligation as a result of a past event1 (in this case a constructive obligation); it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation.
Contingent liabilities Natural disasters – Miscellaneous considerations
A contingent liability is:
- A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity, or
- A present obligation that arises from past events, but is not recognised because it is either not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or the amount of the obligation cannot be measured with sufficient reliability
Contingent liabilities are not recognised, but they are disclosed.
When an entity is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability.
When a previously contingent liability, for example, a legal obligation to repair environmental damage as a result of a natural disaster, is no longer contingent and it meets the recognition requirements of IAS 37, it is recognised and measured in accordance with IAS 37.
Expenditure to be settled by a third party Natural disasters – Miscellaneous considerations
When the expenditure required to settle a provision is expected to be settled by a third party and the entity will not be liable if the third party fails to pay, the entity has no liability and no provision is recognised. An example might be when the entity is occupying a facility leased from another party and that other party is liable for repairs.
Going concern Natural disasters – Miscellaneous considerations
Deterioration in operating results and financial position due to natural disasters after the reporting period may indicate a need to consider whether the going concern assumption is still appropriate. If the going concern assumption is no longer appropriate, IAS 10 Events after the reporting date states that the effect is so pervasive that it results in a fundamental change in the basis of accounting, rather than an adjustment to the amounts recognised within the original basis of accounting. Financial statements prepared on a ‘non-going concern’ basis of accounting may still be described as complying with IFRS as long as that other basis of preparation is sufficiently described in accordance with IAS 1 Presentation of Financial Statements. IAS 1 requires specific disclosures either when:
- the financial statements are not prepared on a going concern basis, or Natural disasters – Miscellaneous considerations
- when management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.