 Hello and welcome to this session. This is Professor Farhad and this session we would look at IAS section 37, which is part 2. I already looked at part 1 and specifically we're going to look at a nervous contract restructuring contingent assets and environmental obligation. This topic is covered on the CPA exam as well the ACCA exam and an undergraduate international accounting course. As always, I would like to remind you to connect with me only then YouTube is where you would need to subscribe. I have 1500 plus accounting, auditing and tax lectures. If you like my lectures, please like them. If you're listening to me and you like them, please like them. Click on the like button, share them, put them in the playlist, let the world know about them. If they're benefiting you, it means they might benefit other people. So please share the wealth. This is my Instagram account. I'm trying to grow my account. This is my Facebook and I do have a website. On my website you can donate and support the channel if you chose to and that's greatly appreciated. Also on my website, I often have CPA offer right now. Becker CPA Review is offering $1,000 off of the Becker Bundle with unlimited access. All four parts of the CPA exam. Becker is the gold standard in CPA preparation and you will have access to this course as long as you need it. Although you may not be studying today for the exam, you can sign up and use the course as a supplement for your college studies. Let's go ahead and talk about onerous contract, which is what is that contract? It's a contract that you signed. You signed the contract, but you made a mistake. In what sense you made a mistake? Well, guess what happened? You signed the contract, but the contract cost, whatever you thought you're gonna get, is greater than the benefit because every time you sign a contract, every time you get into a deal, your expectation is the benefit from that deal is greater than the cost. Well, when the cost of the contract, when the unavoidable cost, because you sign it of the contract exceeds the economic benefit to receive from it, then you have maybe a future loss that you have to book. So simply put, the cost and the cost in that contract is greater than the benefit. Well, should you book your future losses? So the question you might be asking yourself, so do we book future losses? You don't book future losses. You don't recognize future losses. Here there is a contract exists. There is a contract and you sign it. You have a commitment. If you studied USGap, under USGap, we have something called a purchase commitment. Let's assume you are Starbucks, a coffee shop Starbucks. And Starbucks would need to buy the coffee beans to make coffee for their customers. So let's assume they sign a contract today to buy 100,000 tons of coffee beans. And right now, one ton, I don't know what the Starbucks, what the ton for coffee, I'm not sure if they sell it by ton, but let's just say one ton, they can buy it today for, I don't know, let's make it $100. Today is eight. What's today's date? Today's date is eight, seven, eight, seven. So today is eight, seven. Now, let's assume by the time and the contract would allow them to buy it up until 1231. And let's assume by 1231, they decided to buy it, they decided to execute the contract, but the one ton now, they can buy it for $95. What happened is, because they are committed to buying it at 100, and now it's at 95, they made a purchase commitment. They get into a contract and the contract basically worked against them. So they basically what they have is a loss and then they would need to book a loss, basically a purchase commitment. Another example will be something like this. This company produces chocolate candies. It has a non-canstable lease, so they cannot cancel it on a building in South Carolina. Now, the company wanted to move to Mexico. The lease expired December 31st year two, so it's a two year lease, and it's classified as an operating lease. We'll talk about operating lease later. The annual lease is 120,000. In October of year one, the company closes the South Carolina facility and moved to Mexico. And the company believed they cannot sub-lease the building, or maybe they are not allowed to sub-lease the building. Either they cannot or they're not allowed. Let's assume they are not allowed. Therefore, they're stuck with the lease. Because there's no future economic benefit expected from the lease. Basically, the lease becomes a nearest contract. Basically, we are at a loss here. There's an unavoidable cost of fulfilling the lease contract for year two. So, basically, we're going to have to come up with 120,000 and get no benefit from it. Because of this, we booked the expense in year one. So, we'll have to book an expense, debit and expense, and credit liability. This is a credit. So, this is the debit, and this is the credit. It should have been intended, but that's fine. So, you know what the point is. So, this is how it works. The next topic we're going to work with, with IS-37, is restructuring. When a company goes through a restructuring program, and what is a restructuring program? It's a program that's planned and controlled by management that materially changes either the scope of the business, what we're doing, or the manner of which the business is conducted. So, what are examples of restructuring? And companies go a lot of restructuring on a continuous basis. My wife worked with J&J, Johnson & Johnson, and every, I would say, on average, every year and a half, there's a restructuring, and they moved her from one department to another, or they canceled that department, they merged it with someone else, or they created a new department, and she moved to that department. So, restructuring is constantly happening at companies. So, examples of it in the real world will be the sale or the termination of a line of business. Basically, also, that's an example of restructuring. Basically, you are producing a product for basketball and for soccer and for hockey. So, you discontinued the soccer, and you still have the hockey and the basketball. You terminated a line of your business. You might, the closure of a business location in a country, basically, you shut down your operation in a certain country. For example, Walmart shut their operation in Germany. A change in management structure, and this is what my wife goes through, change in management structure, and the fundamental reorganization that has a material effect on the nature and the scope of the entity's operation. Basically, we change the operation in a way that's really, it's given us a different picture of what the company do. Now, compared to US GAAP, it's a little bit different. Let's talk about the differences. Under IAS 37, when should we recognize this structure? When should we recognize the liability? It's when the entity has a detailed formal plan and has raised a valid expectation in those affected by the plan. So, simply, they have the plan and they told the people that you're going to be affected. And how would they tell them, either by announcing the main feature of the plan or by implementing the plan? This is how they know that they are affected. Usually, my wife, they have what's called a town meeting, and every time there's a town meeting, she would roll her eyes and say, well, we're going through another restructuring again. So, this is when you would recognize it. Under US GAAP, it does not allow recognition of a restructuring provision until liability has been incurred. Here, you have to incur some liability. The existence of the restructuring plan and the announcement does not necessarily create a liability. Under IFRS, as long as you announce it, basically, you have a liability under US GAAP. Why under US GAAP? Because they think you might change your mind. Therefore, the US GAAP would allow you to book that liability later. So, the restructuring provision and related loss may occur at a later date until you start the actual process, the actual restructuring versus IFRS, as soon as you announce it, and the people are aware of contingent asset. What are contingent assets? Well, let me just, first of all, make it easy for you. If we are dealing with US GAAP, I would say there's no such thing as contingent asset, and we can live with that. Well, let's talk about IFRS. A contingent asset is a probable asset that arises from a past event and whose existence will be confirmed only by the occurrence or a non-occurrence of a future event. So, a contingent asset means you might have an asset. Okay, you might receive cash, you might receive some piece of land, you might receive a building, warehouse, we don't know, but it's contingent upon an event. A lawsuit is a good example. For example, you suit someone, you're the plaintiff and you're waiting for them to pay you. You might have a contingent asset because if they pay you, you have a contingent asset. The IFRS rules are a little bit different than GAAP. Contingent asset should not be recognized, but should be disclosed when the inflow of economic benefit is probable. So, if it's probable, okay, if it's probable, okay, so generally speaking, they should might be recognized, but it should be disclosed if it's probable. If the realization from a contingency is determined to be virtual certain. Now, this is where IFRS really differ from GAAP. What does virtual certain mean? It's mean that's almost 100% you won or you're going to have that money. For example, a refund from the government or the dispute between you and the government and they're going to give you a refund. Then the related benefit is considered to me the definition of an asset and recognition is appropriate. So, how do you decide what's virtually certain? Well, basically, that's it. We got the asset. So, basically, there's no reason not to have the asset. There's almost 100%. This is what virtual certain is. So, under IFRS, they have a more liberal rules because you can recognize the asset earlier. US GAAP, you really don't recognize the asset until realized. In other words, under US GAAP, there's no such thing as contingent asset. You don't book a future gain or you don't say I'm going to be receiving something and I'm going to record an asset. Wait, if you're going to receive something, wait until you get it, then record it. Under IFRS, if it's virtually certain, yes, I'm positive I'm going to receive it, then you might be able to record it, okay, different rules. Let's talk about a summary of the contingent assets and contingent liabilities. And we covered contingent liabilities in the prior session. Let's separate them and review contingent liabilities. Remember, for a contingent liability to be recognized, to have a provision, it has to be, it has to meet two conditions. It has to be more likely than not. And again, we'll talk in IFRS here, 50% plus, okay? And it has to be reliable, it has to have a reliable measure. So, you need two conditions, more than 50%. And you can, you know the dollar amount, you can measure it reliably. If you don't know the dollar amount, you disclose. If it's not probable, there's not a good chance you disclose. And if it's remote, you don't have to do anything. This is for liabilities. Again, for assets, if we are talking you as gap, we just kind of, we don't have this. Under asset, if it's not probable, you don't disclose it. If it's probable, you disclose it. I mean, under, under gap, you might be able to disclose it, but you have to be very, very careful on how you disclose it. Under IFRS, virtually certain, you can recognize it. And this is where it doesn't exist under USGAP. Under USGAP, say, don't book an asset. Don't book a future asset. Basically, what you're saying is, I'm going to debit a receivable in credit again or credit revenue. You don't do this under USGAP until you actually get it. Then you debit cash rather than receivable and you credit gain or credit revenue. But under IFRS, they're a little bit more liberal. The last topic in this session under IFRS, under IFRS is environmental obligation. And this is called IAS 37 Part B. What's an environmental obligation when the company is responsible for doing a cleanup? Okay, for example, if there's a spill, an oil company had a spill. For example, Bridge Petroleum, they had a spill in the Gulf of Mexico. Or it doesn't have to be a spill. Let's assume you are responsible for restoring the land or its original use after you use it, after you use it, whatever reason to take out the natural resources. So when do you have to recognize that environmental obligation? First, you have to have an obligation. You have to have a present obligation as a result of a past event. The past obligation event is the contamination of land. For example, if you have land contaminated, a present constructive obligation exists because the past contact, because you contaminated that land, create a valid expectation on the part of those affected by the entity that would clean up the contamination. You contaminated the land and there's a valid expectation you need to clean up. Then you also have to have to, this is the first condition. The second condition is you have to have an outflow of resources. Okay, and that outflow is probable. Well, if you have to clean up, it's probable because the contamination has occurred and the company has a policy of cleaning all contamination and outflow is a constructive obligation. It's more likely than not. It's pretty much certain. If you have to clean up, you have to clean up because most countries, they have rules about the environment. Some are more strict than other. And the third obligation, you have to have a reliable estimate of the obligation and you should be able to do that. The company must determine whether this criteria is met. If so, a provision would be recognized for the best estimate of the cost and we talked about the best estimate in the prior session. If not, if you cannot get the best estimate, then a disclosure would be made because there's a greater than a remote likelihood of an outflow of resource. Of course, if you are involved in an environmental cleanup, you're going to have to at least disclose because even if you cannot know the amount, but you know you have an obligation, therefore you have to disclose. This concept is very similar to asset retirement obligation, IRO. And when you have those environmental obligation, you have to record them at the discounted present value. Simply put, let's assume you have an obligation and that obligation, it's only three years from now, you have to do a cleanup and that cleanup, it's going to cost you $100,000. That's your best estimate, but that's three years from now. This is year one, this is year two, and you have to pay it in year three. But you are standing here. What you have to do is you have to discount the $100,000 and record the liability at, for example, I'm just going to make this number up, $88,000. What does that mean? It means for the next three years, you're going to have interest costs in total of $12,000, not per year in total, in total $12,000 because it's recorded at the discounted rate. So whether they come up with that $88,000, I just made it up based on some discounted rate I just made up. So I illustrate the point. So those liabilities will have to be recorded at the discounted present value because sometime it's going to take you some time to come to start, to start paying out the cash. If you have any questions about this topic, please email me. If you happen to visit my website, I strongly encourage you to do so. Please consider donating. And if you're studying for your CPA exam, as always, study hard. It's worth it. Good luck.