Invitation to Comment - Exposure Draft (Exposure Draft IASB/ED/2024/8) – Provisions – Targeted Improvements, Proposed Amendments to IAS 37

Mr. Andreas Barckow, Chair
International Accounting Standards Board
Columbus Building
7 Westferry Circus
Canary Wharf
London, E14 4HD
United Kingdom

Dear Mr. Barckow,

RE: Invitation to Comment - Exposure Draft (Exposure Draft IASB/ED/2024/8) – Provisions – Targeted Improvements, Proposed Amendments to IAS 37

The Canadian Bankers Association (“CBA”)1 would like to thank the International Accounting Standards Board (“IASB”) for the opportunity to comment on the Provisions – Targeted Improvements Exposure Draft (the “ED”). We appreciate the significant effort by the IASB to address the current application issues under IAS 37 and to set out proposals to clarify the requirements for stakeholders. In general, we agree with the IASB’s proposal to align the definition of a liability in IAS 37 with the Conceptual Framework for Financial Reporting. We also agree with the guidance in the proposed paragraph 14P for threshold-based obligations and the replacement of IFRIC 21. We are, however, concerned about the potentially significant implications of some of the proposals, as outlined below.

Measurement – Expenditure required to settle an obligation (Question 2 of the ED)

We disagree with the proposal to align the type of costs that an entity includes as expenditure required to settle an obligation with the type of costs identified in paragraph 68A of IAS 37 in assessing whether a contract is onerous. While we agree that both economic benefits and unavoidable costs of meeting a contractual obligation should be considered in assessing whether a contract is onerous, we do not agree that the same costs should be applied in the measurement of provisions. Costs considered in an onerous contract assessment are those that are necessary to fulfil a contract (including an allocation of “fixed costs”). However, a provision should include the unavoidable costs to settle the obligation. In practice, this is usually the amount paid to settle the obligation. Therefore, we believe the existing guidance provided in paragraph 36 in IAS 37 is appropriate. The proposal to include an allocation of “fixed costs”, which would be incurred regardless, does not reflect the economic reality of the obligation that gives rise to the provision.

We are also concerned with the operational burden this proposal would add to our existing process, potentially requiring new tools to accurately track and allocate internal costs to measure provisions. In measuring provisions that do not settle for an extended period (e.g., asset retirement obligations), entities would need to apply judgment to determine the types and amounts of additional costs to include and to estimate these costs into the future. The proposed approach would result in an increase in estimation uncertainty, as compared to current practice.

Finally, we noted that the IASB does not prescribe an allocation methodology. This would result in divergent approaches, reducing comparability between entities for the same type of provisions. We question the value this proposal will add for users of financial statements.

As a result, we strongly recommend the IASB reconsider the measurement proposal, as described in paragraph 40A.

Discount Rates (Question 3 of the ED)

We agree with the proposal in paragraph 47, which specifies that the discount rate used to measure the provision should reflect the risk-free rate. We believe that the added guidance in the proposal will help reduce diversity in practice. However, we share the concern noted in paragraph BC79 in the Basis for Conclusions on the inconsistency this proposal will create between US GAAP and IFRS for asset retirement obligations and environmental rehabilitation obligations. For banks that are dual reporters, the proposed requirement may create a need to apply different discount rates in measuring such long-term provisions.

We are also concerned about application of the proposed guidance, especially to a group of similar provisions. The proposed guidance in paragraph 47 does not specify how frequently a risk-free rate should be assessed for relatively similar provisions that arise from separate arrangements. For example, an entity which operates in multiple physical locations may enter into a lease for each location, resulting in multiple asset retirement obligation provisions. The entity would have to determine the appropriate risk-free rate to use each time it signs a lease and sets up an asset retirement obligation, resulting in a significant operational burden. To address this concern, we recommend the IASB provide a practical expedient that would allow entities to use the same discount rate for a group of provisions with similar characteristics. This is similar to paragraph B1 in IFRS 16, which allows an entity to apply the IFRS 16 requirements to a portfolio of leases with similar characteristics if it reasonably expects that the effects on the financial statements of applying the requirements to the portfolio would not differ materially from applying the requirements to the individual leases within that portfolio.

Disclosure
We disagree with the proposed requirement to disclose all discount rates used in measuring provisions and the approach used to determine these rates. Canadian banks generally do not have large, long-term provisions, so the impact of discounting is often not material. To meet the proposed disclosure requirement in paragraph 85(d), an entity would need to disclose multiple different discount rates that do not materially impact the financial statements. We do not believe this disclosure would provide incremental benefits to users of the financial statements.

Paragraph 125 of IAS 1 already requires entities to disclose “information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year”. As such, we believe the existing disclosure requirements in IFRS are sufficient for users of the financial statements to obtain material information about discount rates used in measuring provisions. We recommend the IASB remove the proposed disclosure requirement in paragraph 85(d).

We agree with the IASB’s proposal to align the definition of a liability as discussed in IAS 37 with the Conceptual Framework, as well as the expanded guidance on the present obligation criterion. However, we also acknowledge that the proposed guidance consists of a multi-layered structure with three additional conditions introduced to the present obligation criterion. This initially appears to be a significant change in the assessment process and would require sizable efforts to educate relevant stakeholders, such as internal legal counsel. We believe that for most provisions, the same recognition conclusion would be reached under the proposed and current guidance. Therefore, we recommend the IASB include examples or information, either in the Basis for Conclusions or via educational material, to explain the change in process required to assess provisions.

With respect to the past event condition, we recommend the IASB remove the following wording from paragraph 14P:

… The entity recognises a provision if the recognition criteria in paragraphs 14(b) and 14(c) are met – that is, if:

1. It is probable that the entity’s activity will exceed the threshold and the entity will be required to transfer an economic resource (see paragraphs 14(b)); and,
2. A reliable estimate can be made of the amount of the obligation (see paragraph 14(c)).

This wording is derived from the two recognition criteria for provisions that are discussed in paragraphs 14(b) and (c). Given the focus of the proposed guidance in paragraphs 14A to 14U is the present obligation criterion, it is unclear why the other two recognition criteria for provisions are referenced in paragraph 14P. In addition, paragraph 14K already specifies that “the probability of a transfer does not affect whether an obligation meets the present obligation recognition criterion”. Therefore, the wording noted above should be removed from paragraph 14P so the discussions from paragraphs 14A to 14U focus on the present obligation criterion only.

Application of retrospective transition requirements to the amendments will require potentially significant efforts to avoid using hindsight in accordance with paragraph 53 of IAS 8. We are also concerned that reassessing contingent liabilities and provisions for comparative periods would not be meaningful to the users of financial statements as these assessments and estimates would be based on information that is not only outdated, but also potentially in conflict with the actual events or outcomes observed in the period after the comparative period. We therefore recommend the IASB provide a modified retrospective application approach, similar to the transitional provision described in the proposed paragraph 94D, allowing entities to apply the amendments only to outstanding obligations at the date of transition, with no restatement of comparative information.

Regarding the effective date of the proposed amendments to IAS 37, we urge the IASB to consider the implementation effort required in the context of all other new IFRS Accounting Standards becoming effective and other active projects within the next two years (e.g., Classification and Measurement of Financial Instruments under IFRS 9 and 7, IFRS 18, Dynamic Risk Management and final amendments to the Financial Instruments with Characteristics of Equity project). We urge the IASB to consider these projects holistically to avoid creating undue pressure on entities to undergo more than one challenging adoption in the same fiscal year.

Overall, we find the decision trees in Section B of the Guidance on Implementing IAS 37 to be helpful. It identifies the key questions to ask for the present obligation criterion and the different conclusions that could be reached depending on the responses to those questions. We recommend the IASB move the decision trees to the main body of IAS 37 or an appendix to IAS 37, where it would be more broadly accessible to the users of IFRS Accounting Standards.

We are concerned that Example 15 provides an overly simplified analysis of the complex and evolving topic of climate-related commitments, targets, and transition plans. This may lead to potential over-interpretation and unintended consequences, particularly as climate-related commitments are subject to increasing scrutiny from a broad range of stakeholders with different, and often competing, interests.

In particular, the analysis of whether the fact pattern creates an obligation condition is overly simplified and does not reflect the complex and competing factors that may impact an entity’s ability to realize its commitments. Example 15 prematurely concludes that the entity owes a responsibility to society and that the entity has no practical ability to avoid discharging its responsibility. Given the evolving nature of climate commitments and actions (i.e., they may be dependent on broader government, societal or scientific developments), entities’ actions on climate change are often voluntary and communicated as such to the public. The example does not consider that entities may modify or retire voluntary commitments if they are no longer reflective of the entity’s operating environment or outlook on external factors, such as broader governmental policies or societal or scientific developments, as evidenced by the recent withdrawals by certain companies of their climate-related commitments. We therefore disagree with the Board’s assertion that an entity’s public statement of its commitments imposes on the entity responsibilities that it has no practical ability to avoid.

The example also states that the conclusion has been determined having considered all the facts and circumstances of the entity’s commitments but provides no indication as to which facts and circumstances were relevant to this assessment, or how they have been weighed against each other. For example, Example 15 does not address whether the timeline to complete the stated commitment is a key factor, and therefore whether long-term and short-term commitments may result in different conclusions on the obligation condition. It also does not consider the specificity and status of the entity’s plans to achieve the commitment, or any caveats that an entity has communicated publicly on its ability to achieve its commitment, such as the need for broader government and societal changes.

We therefore recommend that the Board remove Example 15. Should the Board decide to keep this example, the analysis in Example 15 should be expanded to incorporate more of the analysis from the Climate-related Commitments IFRS Interpretation Committee (IFRIC) agenda decision (“the agenda decision”), which examined a similar fact pattern to the one presented in Example 15. In particular, while the agenda decision identifies that an entity would need to apply judgement and consider the relevant facts and circumstances to determine whether it has a constructive obligation, it does not attempt to provide a definitive conclusion on whether there is a constructive obligation in this fact pattern. This approach would enable entities to weigh their own facts and circumstances, without the potential for overinterpretation or misinterpretation resulting from a conclusion on the existence of an obligation condition in Example 15. We also suggest incorporating more of the analysis from the agenda decision relating to the “present obligation as a result of a past event”, to highlight that provisions are not recognized for future operating costs and that neither stating a commitment nor taking actions that affirms the entity’s intention to fulfil that commitment are events that create an obligation. If the guidance is expanded, we suggest that the Board provide a further opportunity to comment on these proposals given the complexity and diversity in fact patterns associated with climate-related commitments.

Overall, we find that some of the proposed IAS 37 amendments, while intended to enhance clarity, introduce significant operational challenges and we are concerned that this will not translate into corresponding benefits to financial statement users. We are concerned that the revised requirements for measuring provisions may introduce additional judgement and estimation uncertainty, potentially leading to less consistent and comparable reporting across companies. We recommend that the IASB provide an option for the transition requirements to be applied using a modified retrospective approach given the concerns noted above. Finally, we are concerned that Example 15 added to the Guidance on implementing IAS 37 may have significant unintended consequences and recommend that the Board remove this example. Given the concerns highlighted above, we believe additional revisions are needed to make the adoption of the proposed amendments more practicable for entities and more meaningful for financial statement users.

Thank you for considering our comments. We would be pleased to discuss our response at your convenience.

Sincerely,

Darren Hannah

¹The CBA is the voice of more than 60 domestic and foreign banks that help drive Canada’s economic growth and prosperity. The CBA advocates for public policies that contribute to a sound, thriving banking system to ensure Canadians can succeed in their financial goals. www.cba.ca.