This report analyses the most recent financial reports of two companies; Sino Gas and Energy of Australia (2014), and Solar World of Germany (2015). Sino Gas and Energy reported total provisions of $97,166 that constituted 0.09% of the total assets. Solar World reported total provisions of k€ 49,466 that constituted 5.69% of the total assets. The provisions for the two companies are listed below in descending order based on their book values:
Sino Gas and Energy $
Other provisions 60,837
Employee entitlements 36,329
Total 97,166
Solar world k€
Warranties 24,653
Pensions 10,704
Litigation risks 9,190
Other provisions 4,522
Restoration obligations 377
Total 49,446
Sino Gas and Energy most frequent provision is the employee entitlement, while for Solar World the most frequent provisions are warranties, pensions and litigation risks. Solar World had more provisions both in terms of the provisions reported and in terms of book value as compared to Sino Gas and Energy.
Sino Gas and Energy makes provisions for legal claims, service warranties, and other obligations whenever the group recognizes an obligation it has a s a result of past events, there is a likelihood that there will be an outflow of resources to settle the obligation, and the amounts can be reliably estimated (Sino Gas and Energy, 2014). Sino Gas and Energy does not make provisions to cater for possible future operating losses (Sino Gas and Energy, 2014). Sino Gas and Energy measures the obligation as the present value of the management’s best estimate of the amount of resources that will be required to settle the obligation at the end of reporting period (Sino Gas and Energy, 2014).Sino Gas and Energy uses a discount rate that reflects the company’s pre-tax cost of capital that reflects a fair assessment of the time value of money and the risk of the particular liability (Sino Gas and Energy, 2014).
Solar world makes provisions to the extent to which a current legal obligation exists to a third party arising from a past event and that will require an outflow of resources in the future, and the company can make a reliable estimate of the amount of the obligation (Solar World, 2015). Solar World measures provisions that will not require the outflow of resources in the coming year at the present value of the expected obligation (Solar World, 2015).Solar world uses a pre-tax rate discount rate that reflects the current market assessment of the time value of money and the risk attached to the particular liability (Solar World, 2015).
For some provisions that Solar World expects some refund say for example an insurance refund, the refund when certain is recognized separately as an asset(Solar World, 2015). The expense of setting up such a provision is recognized in the income statement less the amount of refund (Solar World, 2015). Solar World sets up provisions for warranties the time the item is sold or when the service is rendered (Solar World, 2015).
Solar World measures the provisions for pensions by calculating the difference between the present value of the defined benefits less the yet unrecognized past service costs and the yet unrecognized actuarial losses (Solar World, 2015).
Sino Gas and Energy reported the following schedule showing the changes in provisions between 2013 and 2014.
2014 2013
$ $
Other provisions 60,837 214,250
Beijing Representative Office tax - 140,622
Employee entitlements 36,329 12,220
Total 97,166 367,092
Solar World reported the following schedule for changes in provisions between 2014 and 2015.
2015 2014
k€ k€
Warranties 24,653 13,309
Pensions 10,704 9.359
Litigation risks 9,190 5,069
Other provisions 4,522 1,883
Restoration obligations 377 235
Total 49,446 30,355
Disclosure requirement IAS 37 and AASB 137 – Provisions, Contingent Liabilities, and Contingent Assets
IAs 37 and AASB 137 provide guidelines to a reporting entity on how to report provisions, contingent liabilities, and contingent assets. Provisions are liabilities of uncertain timing or amount; contingent assets are probable assets, while contingent liabilities are probable liabilities (IAS Plus, 2016). The objective of the IAS 37 is to ensure that the reporting entity applies the appropriate recognition and measurement criteria to provisions, contingent liabilities and contingent assets and makes sufficient disclosure in the notes to the financial statements (IAS Plus, 2016). Both Companies are in compliance with IAS 37 and AASB 137.
Recognition of a provision
IAS 37.14 requires a reporting entity to recognize a provision if:
A present obligation (legal or constructive) has arisen from a past event i.e. there must be an obligating event. I AS 37.10 explain that a constructive obligation arises when a past practice creates valid expectations to a third-party (IAS Plus, 2016). For instance, Solar World offers warranties on its products and therefore, creates valid expectations on its customers when customers buy their products (IAS Plus, 2016).
There is a probability that there will be an outflow of the firm’s resources to settle the obligation
The amount of the obligation can be reliably measured. If the amount cannot be reliably measured or the firm cannot obtain a best estimate, the entity is required to recognize a contingent liability and disclose it in the financial statements. However, according to IAS 37.86 an entity is not required to make a disclosure on a contingent liability if payment is remote.
Solar World and Sino Gas and Energy indicate that they adhere to these guidelines whenever they are recognizing their provisions.
Relationship between Provisions and Contingent Liabilities
AASB 137.12-13 distinguishes between provisions and contingent liabilities and assets by guiding that while all provisions are contingent because the timing and the amount of cash flow is uncertain, provisions refer to those liabilities that the amount of cash flow required to settle the obligation can be reasonably measured. However, contingent liabilities and assets are dependent upon the occurrence or nonoccurrence of some future event. Therefore, contingent assets and liabilities have to be reported separately (AASB, 2010).
Measurement of Provisions
IAS 37.36 requires a reporting entity to recognize a provision equivalent to what it would cost the organization to settle the obligation at the reporting date (IAS Plus, 2016). Therefore, the reporting entity measures provisions as follows:
For one off events such as restructuring and law suits, the entity should recognize them at the most likely cost of settling them
Provisions of large populations such as warranties should be recognized using the probability - weighted expected value (IAS 37.39). Solar World recognizes its provision for warranties by considering the number of customers, the number of complaints and using a pre-tax discount rate.
Both measurements are discounted at the pre-tax cost of capital that incorporates the current market assessment of the time value of money and the risk particular to the liability (IAS37. 45 and IAS 37.42. Sino Gas and Energy discounts noncurrent provisions at a pre-tax discount rate that reflects the current market assessment of the time value of money and the risk attached to a particular asset. The increase in the provision over time is recognized as an interest expense (Sino Gas and Energy, 2014).
IAS 37 does not require reporting entities to report their contingent liabilities. However, the reporting entities should disclose all contingent liabilities in the notes to the financial statements unless the payment is remote. Contingent assets should not be disclosed.
Sino Gas and Energy as and Solar World did not disclose any contingent liabilities in their financial statements indicating that the firms did not have any contingent liability such as a pending law suit that they ought to have reported.
Cultural Differences
Gray (1998) as cited by Chand, Patel and Day (2008) argue that culture is a possible reason for differences between countries and regions in their financial reporting. Comparing the Austaralian Firm to the Germany Firm, the Australian firm has reported only two items under provisions i.e. other provisions, and employee entitlement provisions, on the other hand the Germany firm has reported five items under provisions; warranties, pensions, litigation risks, other provisions, and restoration obligations.
There are cultural differences between Germany and Australia that may influence how entities in the two countries report their financial performance. These differences can be looked at two levels the country level and the firm specific level.
At the country level Chand, Patel and Day (2008) notes that the following factors cause differences in financial reporting:
Tax rates – Germany corporate tax rate has averaged 39.78 from 1995 to 2015 (trading Economics, 2016). However, German cornet corporate rate stands at 29.65%. On the other hand, Australia taxes corporate profits at 30% (Trading Economics, 2016). A higher tax regime may serve as an incentive to recognize more provisions and thus lower the reported earnings and thus the tax charged on the company.
Capital markets regulations, Chand Patel, and Day (2008) argue that legal protections for shareholders were strongest in English common law countries such as Britain, Australia, and Singapore, and weakest in countries with French-style laws, with German and Scandinavian countries being in the middle ground. Small companies in countries with weak laws have difficulties raising external finance but, large companies irrespective of where they are located are able to raise external finance.
The firm specific factors that may cause differences in financial reporting include:
The listing status, the capital markets of both Australia and German require firms that are listed to prepare their accounts in line with the IFRS. So this would not account for the differences in the reporting of the provisions since both firms were following the IAS 37 or the AASB 137.
Both firms had a mixture of both debt and equity in their capital structure. Companies with unusual high gearing may be pressured by creditors to recognize more provisions in order to reduce the earnings declared and possibly reduce the amount of dividends paid to shareholders. Creditors worry that if a company pays too much of their earnings in dividend there may be insufficient funds to repay them the money they have loaned to the firm.
References
AASB, (2010). AASB 137— Provisions, Contingent Liabilities and Contingent Assets [online] .
Available at: http://www.aasb.gov.au/admin/file/content105/c9/AASB137_07-04_COMPoct10_01-11.pdf [Accessed 30 Mar. 2016].
Chand, P., Patel, C. and Day, R. (2008). Factors Causing Differences In The Financial Reporting
Practices in Selected South Pacific Countries In The Post-Convergence Period. Asian Academy of Management Journal, 13(2), pp.111-129.
IAS Plus, (2016). IAS 37 — Provisions, Contingent Liabilities and Contingent Assets. [online]
Iasplus.com. Available at: http://www.iasplus.com/en/standards/ias/ias37 [Accessed 30 Mar. 2016].
Sino Gas and Energy, (2014). Annual Report.
Solar World, (2015). Annual Report.
Trading Economics, (2016). Germany Corporate Tax Rate | 1995-2016 | Data | Chart |
Calendar | Forecast. [online] Tradingeconomics.com. Available at: http://www.tradingeconomics.com/germany/corporate-tax-rate [Accessed 30 Mar. 2016].
