Statement of Principles Assets, Contingent Assets and Contractual Rights Prepared by: Public Sector Accounting Board August 2013 Comments are requested by November 29, 2013 PSAB
Commenting on this Statement of Principles This Statement of Principles reflects proposals made by the Public Sector Accounting Board (PSAB). It presents key principles that the Board expects to include in a future exposure draft. Individuals, governments and organizations are invited to send written comments on this Statement of Principles. Comments are most helpful if they are related to a specific principle, paragraph or group of paragraphs. Any comments that express disagreement with the proposals in the Statement of Principles should clearly explain the problem and include a suggested alternative, supported by specific reasoning. All comments received will be available on the website shortly after the comment deadline, unless confidentiality is requested. The request for confidentiality must be stated explicitly within the response. For your convenience, a PDF response form has been posted with this document. You can save the form both during and after completion for future reference. You are not restricted by the size of the interactive comment fields in the response form and there is also a general comments section. Alternatively, you may send written comments by email in Word format to: ed.psector@cpacanada.ca To be considered, comments must be received by November 29, 2013, addressed to: Tim Beauchamp, Director Public Sector Accounting Chartered Professional Accountants of Canada 277 Wellington Street West Toronto, Ontario M5V 3H2
Highlights The Public Sector Accounting Board (PSAB) proposes, subject to comments received on this Statement of Principles and following its due process, to expose three proposed new Sections on assets, contingent assets and contractual rights. The Sections would apply to public sector entities that base their accounting policies on the CICA Public Sector Accounting (PSA) Handbook. PSAB s Conceptual Framework project may have implications on the proposals in this Statement of Principles to the extent that a change to the assets definition is proposed. Implications of the Conceptual Framework project, if any, will be addressed as they arise. Main features The main features of this Statement of Principles are as follows: Part I Assets Additional guidance on the definition of assets is provided. Disclosure of assets that are not recognized is required. Part II Contingent Assets Contingent assets are defined. Disclosure of contingent assets is required when the occurrence of the confirming future event is likely. Part III Contractual Rights Contractual rights are defined. Disclosure of contractual rights is required. Other proposals Included in this Statement of Principles are other potential amendments to existing standards that could arise from the acceptance of the proposals on assets, contingent assets and contractual rights. They relate to improvements in wording and suggested deletions. Comments requested PSAB welcomes comments from individuals, governments and organizations on all aspects of the Statement of Principles. When comments have been prepared as a result of a consultative process within an organization, it is helpful to identify generically the source of the comment in the response. This will promote understanding of how the proposals are affecting various aspects of an organization. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS i
Comments are most helpful if they relate to a specific principle, paragraph or group of paragraphs. Any comments that express disagreement with the proposals in the Statement of Principles should clearly explain the problem and include a suggested alternative, supported by specific reasoning, for alternative wording. Supporting reasons for your comments are most valuable when they demonstrate how the Statement of Principles proposals, or your alternatives: produce more relevant information for accountability and decision-making by external users; improve the representation of the substance of the underlying transaction or event; contribute to improved measures and understanding of financial position and annual results; facilitate enhanced comparability; and provide sufficient information for external users to understand the financial statements. Please respond to the following questions and explain your reasoning: Effects Analysis 1. Are there other implications of the proposals that should be considered? If so, please provide a detailed explanation. Part I Assets 1. Is the proposed guidance relating to the definition of assets useful? Are there other aspects that should be considered? 2. Do you agree with how PSAB has dealt with service potential in paragraph.052? 3. Do you agree with the proposed disclosure requirements? Part II Contingent Assets 1. Do you agree with the proposed definition of contingent assets? 2. Do you find the proposed guidance on the contingent assets useful? Are there other aspects that should be considered? 3. Do you agree with the proposed disclosure requirements? 4. Do you believe that there is some threshold (i.e., virtual certainty) at which contingent assets should be recognized? 5. In some cases, likely contingent assets may be recognized as part of a reduction to a contingent liability (refer to paragraph.111). Do you agree with limiting the recognition of contingent assets to this situation only? Part III Contractual Rights 1. Do you agree with the proposed definition of contractual rights? 2. Do you find the proposed guidance on the contractual rights useful? Are there other aspects that should be considered? 3. Do you agree with the proposed disclosure requirements? ii STATEMENT OF PRINCIPLES AUGUST 2013
Assets, Contingent Assets and Contractual Rights TABLE OF CONTENTS PARAGRAPH Purpose and scope....001-.005 The need for a standard....006-.008 Effects analysis....009-.011 PART I ASSETS....012-.068 Economic resources....016-.024 Control....025-.042 Past transactions or events....043-.050 Future economic benefits....051-.062 Disclosure....063-.068 PART II CONTINGENT ASSETS....069-.126 Characteristics of contingent assets....075-.083 Existence uncertainty....084-.092 Disclosure vs recognition....093-.117 Disclosure....118-.126 PART III CONTRACTUAL RIGHTS....127-.152 Defining contractual rights....132-.142 Reporting of contractual rights....143-.150 Disclosure....151-.152 APPENDIX A Decision tree APPENDIX B Other proposals APPENDIX C Abbreviations and acronyms ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 1
PURPOSE AND SCOPE.001 This Statement of Principles is intended to result in three new CICA Public Sector Accounting (PSA) Handbook Sections on assets, contingent assets and contractual rights..002 The purpose of this Statement of Principles is to propose: (a) additional guidance and general disclosure requirements for assets; (b) a definition of and standards on disclosure requirements for contingent assets; and (c) a definition of and standards on disclosure requirements for contractual rights..003 This Statement of Principles does not include proposals for: (a) changing the existing definition of assets and the general recognition criteria set out in the FINANCIAL STATEMENT CONCEPTS, Section PS 1000, which will be reviewed as part of the Public Sector Accounting Board s (PSAB) Conceptual Framework project; and (b) specific types of assets, contingent assets or contractual rights..004 This Statement of Principles does not address the recognition of intangibles, inherited natural resources and Crown lands, and art and historic treasures, which may meet the definition of assets but are not recognized in accordance with FINANCIAL STATEMENT CONCEPTS, paragraphs PS 1000.57-58. Recognition of these items is a separate and distinct issue requiring further study..005 For the purposes of this Statement of Principles, the term public sector entity has been used to mean governments and those entities applying the PSA Handbook. THE NEED FOR A STANDARD.006 FINANCIAL STATEMENT CONCEPTS, Section PS 1000, provides a definition of assets and some limited guidance. Providing additional guidance will assist preparers and auditors in determining whether an item meets the definition..007 FINANCIAL STATEMENT PRESENTATION, Section PS 1201, provides a general definition of contingencies as well as some disclosure requirements for contingent assets. Including a definition of contingent assets and providing guidance for disclosure requirements for contingent assets would enhance users understanding of what constitutes contingent assets as well as when and how they should be disclosed..008 Public sector entities enter into contracts from which rights to economic resources arise. CONTRACTUAL OBLIGATIONS, Section PS 3390, provides a definition of contractual obligations and requires disclosure of certain obligations in order to provide users with information on expected future liabilities. 2 STATEMENT OF PRINCIPLES AUGUST 2013
Information on expected future assets and related revenue is no less important as it offers information about resources that may be available to meet a public sector entity s obligations or to finance future operations. Providing information on both contractual rights and contractual obligations allows for a balanced view of a public sector entity s future revenue and expenditures, and enhances users understanding of the nature and extent of its resources and affairs. EFFECTS ANALYSIS.009 Part I provides enhanced guidance to assist in determining whether an item meets the definition of assets. It also proposes disclosure of unrecognized assets. This may result in public sector entities reassessing items that meet the definition and in additional disclosures..010 Part II proposes a definition of and disclosure requirements for contingent assets. This may result in reassessment of items that meet the definition and additional information being disclosed..011 Part III proposes a definition of and disclosure requirements for contractual rights. Since the PSA Handbook does not provide guidance on contractual rights, this proposal may result in public sector entities having to determine their contractual rights and disclose information about them. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 3
PART I ASSETS.012 FINANCIAL STATEMENT CONCEPTS, Section PS 1000, provides a definition of assets, key characteristics of assets and limited guidance on some of the key components of the assets definition. This includes guidance on what is meant by future economic benefits and control of an asset. Section PS 1000 also provides guidance on financial assets, non-financial assets and tangible capital assets..013 Assets are defined as economic resources controlled by a government as a result of past transactions or events and from which future economic benefits are expected to be obtained..014 FINANCIAL STATEMENT CONCEPTS, paragraph PS 1000.36, also lists the following three essential characteristics of assets: (a) they embody a future benefit that involves a capacity, singly or in combination with other assets, to provide future net cash flows, or to provide goods and services; (b) the government can control access to the benefit; and (c) the transaction or event giving rise to the government's control of the benefit has already occurred..015 The existing guidance on assets and various components of the assets definition is limited and can be improved to assist in determining whether an item meets the definition of an asset while ensuring that the proposed guidance is more appropriate for the public sector. To achieve this, a review of existing guidance has been conducted and proposed guidance on the key components of the assets definition is provided. This includes addressing questions of what is meant by: (a) economic resources; (b) control; (c) past transactions or events; and (d) future economic benefits. ECONOMIC RESOURCES.016 The following guidance on economic resources is included in FINANCIAL STATEMENT OBJECTIVES, paragraph PS 1100.22: Economic resources are scarce means that are useful for carrying out economic activities, such as consumption, production and exchange. Financial and non-financial resources comprise the economic resources of a government..017 This guidance is very limited and oriented to the private sector. It could be improved upon by emphasizing activities that are predominant in the public sector, which include the redistribution of wealth and the provision of goods and 4 STATEMENT OF PRINCIPLES AUGUST 2013
services. The guidance can also be enhanced by better explaining what is meant by a resource being an economic resource in the public sector..018 Other standard setters commonly describe economic resources as something of value, a useful or valuable possession or means of supplying a want. 1 To embody value, there must be some restriction on its availability. Economic resources often include productive resources, products, money, claims to receive money or ownership of interest in an enterprise. They are described as useful in carrying out economic activities, such as consumption, exchange, production of net cash inflows, reduction of net cash outflows, and provision of goods and services. Proposed guidance.019 Economic resources are resources that embody value. Economic resources embody value if: (a) they are capable of being used in achieving the public sector entity s objectives; and (b) there is some restriction on their availability..020 Economic resources are items that enable the entity to meet its objectives, such as the provision of public goods and services, redistribution of wealth, generation of cash inflows or reduction of cash outflows..021 Without a present economic resource, future economic benefits cannot be obtained. For example, a fire truck (the economic resource) needs to exist before it can provide fire suppression services (the future economic benefits)..022 To embody value as an economic resource there must also be some restriction on its availability. For example, the air we breathe generally cannot be an economic resource unless access to it is restricted..023 Economic resources can arise from, but are not limited to, the following: (a) agreements or contracts (for example, accounts receivable and leases); (b) another government s legislation (for example, transfers receivable); (c) government s own legislation (for example, taxes, fines and penalties); (d) voluntary contributions (for example, donations); or (e) construction and development (for example, roads)..024 Economic resources can be: (a) financial in nature (for example, cash, claims to cash and investments); or (b) non-financial in nature (for example, tangible capital property, prepaid items and inventories of supplies). 1 Other standard setters reviewed that address this topic include: FASAB, FASB, IASB, IPSASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 5
CONTROL.025 The definition of assets specifies that for a government to have an asset, the government needs to control the economic resource. Further, FINANCIAL STATEMENT CONCEPTS, paragraph PS 1000.38, provides additional guidance on control: For an asset to be a government's asset, that government must control the future economic benefit associated with the asset to the extent that it can benefit directly from the asset and generally can deny or regulate access to that benefit by others. For example, the direct benefits of education and health care programs accrue to and are controlled by the individuals who are educated or treated and healed. Therefore, the costs of such programs, which are often called "investments", are excluded from being assets of the government..026 The existing PSA Handbook guidance essentially indicates that for an asset to be an asset of a public sector entity that entity needs to control the economic resource. It further needs to be able to control access to the future economic benefits and, therefore, be able to obtain them and deny or regulate access to those benefits by others. For example, for a fire truck to be an asset of a public sector entity, that entity must first control the fire truck (the economic resource). The entity must also be able to benefit from it through provision of fire suppression services (the future economic benefits) as well as be able to restrict access to those services to others..027 The existing guidance on control of an asset states that a government needs to benefit directly from the asset (refer to paragraph.025). The inclusion of such wording may cause confusion as many economic resources, which are controlled by a public sector entity, are used to provide services to the public. Hence, it is the public that may be seen as benefiting directly. For example, a bus is used to provide transportation services. Although the public sector entity benefits from the use of the economic resource (the bus) by meeting its objective of service provision, one could also argue that the direct benefit (transportation) flows to the public. Therefore, the removal of the term direct may remove the confusion as to which party benefits directly and allows the user to concentrate on the meaning of control of an asset, which entails benefits from the asset and the ability to deny or regulate access to those benefits by others..028 The removal of the term direct does not interfere with the robustness of the guidance on control of an asset and would not result in inclusion of program costs, such as education, as assets. This is because the assets definition and the guidance on control of an asset require the entity to control both the economic resource and access to the future economic benefits. In the case of education programs, the public sector entity cannot control the economic resource (the knowledge obtained through the education programs) or access to the future economic benefits (the economic advantages gained through the knowledge). 6 STATEMENT OF PRINCIPLES AUGUST 2013
The economic resource and access to the future economic benefits are controlled by the individuals who are educated..029 The control guidance in GOVERNMENT REPORTING ENTITY, Section PS 1300, contains a notion of risk of loss to the government. It states that: control is the power to govern the financial and operating policies of another organization with expected benefits or the risk of loss to the government from the other organization's activities..030 An entity that controls an asset has access to benefits associated with the asset, a concept already depicted in the guidance on control of an asset, but it also bears the risks associated with the asset. For example, a public sector entity may hold land that may have a future environmental clean-up cost associated with it. Another example would be an investment the value of which may decline and result in a loss. Therefore, since the notion of risk is very much part of the implications of having control of an asset, it may be appropriate to include it in the guidance on control of an asset..031 Most standard setters agree on the meaning of control, which is generally described as the ability of the government to use or otherwise obtain the future economic benefits from the assets and to deny or regulate access to those benefits by others. 2.032 The Government Accounting Standards Board s (GASB) guidance indicates that control of an asset is the ability of the government to utilize the resource s present service capacity (existing capability to enable the government to provide services) and to determine the nature and manner of use of the present service capacity embodied in the resource. Generally, the government controlling the asset is said to have the ability to determine whether to: (a) directly use the present service capacity to provide services to citizens; (b) exchange the present service capacity for another asset, such as cash; or (c) employ the asset in any of the other ways it may provide benefit..033 The International Public Sector Accounting Standards Board s (IPSASB) Conceptual Framework Exposure Draft 2, Elements and Recognition in Financial Statements, issued in November 2012, provides very similar guidance on control of a resource to that of GASB and, in addition, includes indicators of control that may indicate, but not determine, that control exists. These indicators include: (a) legal ownership; (b) (c) access to or, conversely, ability to deny or restrict access to the resource; the means to ensure that the resources are used to achieve its objectives; and 2 Other standard setters reviewed that address this topic include: AASB, AcSB, FASAB, FASB, GASB IASB, IPSASB, UK ASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 7
(d) the existence of an enforceable right to service potential or economic benefits arising from a resource..034 Standard setters that provide further guidance on control also agree that ownership, possession or legal enforceability are indicators of control but do not necessarily confirm control of an asset. On the other hand, external restrictions on the entity s use of the asset do not necessarily mean that the entity does not control the asset..035 In drafting the proposed guidance on control of an asset, PSAB has also considered the guidance on control provided in GOVERNMENT REPORTING ENTITY, Section PS 1300, and in PUBLIC SECTOR GUIDELINE, PSG-2, Leased Tangible Capital Assets, in order to enhance the existing guidance on control of an asset and keep it consistent to the extent possible and practicable. Proposed guidance.036 For an economic resource to be a public sector entity s asset, the public sector entity must control the economic resource and access to the future economic benefits associated with the economic resource to the extent that it can: (a) determine how the economic resource will be used; (b) benefit from the economic resource through future net cash inflows, reduction of cash outflows or capacity to provide goods and services; (c) deny or regulate access to those benefits by others; and (d) be exposed to the risks associated with the economic resource..037 A public sector entity s control of an economic resource is evidenced by the ability to exchange, hold or use the resource to provide goods and services or to obtain cash. A public sector entity can have control even though it is not exercised as control exists by virtue of the entity s ability to do so..038 Some economic resources are subject to certain external restrictions. For example, there may be external restrictions imposed on the public sector entity s own assets, as is the case with some sinking fund investments. Such restrictions on the use of an economic resource do not negate the public sector entity s control of the economic resource..039 Although control may be seen as applying to an asset as a whole, the concept can also be applied to individual rights that make up the asset. For example, lease agreements unbundle the economic benefits embodied in a single leased property. This may give the lessee the right to possess and use the property and the lessor the right to receive rents and any residual value. Thus, both parties may have assets corresponding to their respective rights..040 Possession or ownership of an economic resource normally entails control of the economic resource and access to the future economic benefits, but that is not always the case. Whereas control of an economic resource and of access to the 8 STATEMENT OF PRINCIPLES AUGUST 2013
future economic benefits is an essential characteristic of an asset, possession or ownership is not. For example, a public sector entity may control the economic resource and access to the future economic benefits through a capital lease arrangement yet not own the economic resource..041 A public sector entity s ability to regulate an economic resource does not, in and of itself, constitute control of an asset. A public sector entity may establish the regulatory environment in an industry or sector within which organizations operate and impose conditions or sanctions on their operations. Such ability does not constitute control by a public sector entity of the assets deployed by these organizations. For example, a pollution control authority may have the ability to close down the operations of entities that are not complying with environmental regulations. However, this power does not constitute control because the pollution control authority s interest extends only to the regulatory use of the economic resources and does not include the ability to control access to the future economic benefits..042 A public sector entity may act as trustee when it administers trusts on behalf of the beneficiaries specified in the agreement or statute. As trustee, the public sector entity merely administers the assets, following the terms and conditions set out in the agreement. It does not control the asset as it cannot determine how the economic resources will be used and does not have access to the future economic benefits as those benefits flow to the beneficiaries. PAST TRANSACTIONS OR EVENTS.043 The PSA Handbook discusses specific past transactions or events giving rise to assets in various Sections of the Handbook. However, broad guidance on past transactions or events that give rise to control of an economic resource, similar to that included in LIABILITIES, Section PS 3200, does not exist..044 Other standard setters provide that for an entity to have an asset, the past transaction or event giving rise to the entity s control of the asset must have already occurred. 3 According to the U.S. Financial Accounting Standards Board (FASB), the definition excludes from assets items that may in the future become an entity s assets but have not yet become its assets. Further, FASB provides the example that an entity does not acquire an asset merely by budgeting for the purchase of a machine..045 Also, the Federal Accounting Standards Advisory Board (FASAB) notes that the government s intent or ability to acquire a resource in the future does not create an asset. For the resource to qualify as an asset, the government already must have acquired the resource or otherwise obtained access to the economic benefits or services it embodies to the exclusion of other entities. For example, the mere existence of the government s power to tax is not an asset because, until 3 Other standard setters reviewed that address this topic include: AASB, FASAB, FASB, IASB, UK ASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 9
the government has exercised that power by imposing a tax and has access to benefits by virtue of completion of a taxable event, no event has occurred to generate resources and there are no resulting economic benefits that the government can control and use in providing programs and services. Proposed guidance.046 It is the occurrence of a past transaction or event on or before the financial statement date that distinguishes a present economic resource controlled by a public sector entity from an economic resource that may be controlled by a public sector entity in the future..047 The past transaction or event that gives rise to control of an economic resource resulting from exchange agreements or contracts usually occurs at the point of exchange. This arises when substantially all the benefits and risks of ownership have been transferred to the public sector entity and normally coincides with the disbursement of funds, exchange of other assets or assumption of liabilities..048 Meeting the eligibility criteria under an authorized transfer program often determines the past transaction or event giving rise to control of an economic resource in non-exchange contracts or agreements. Shared cost agreements (reimbursement arrangements) are an example where the control of an economic resource arises when the recipient incurs eligible expenditures. For guidance on how to account for government transfers, refer to GOVERNMENT TRANSFERS, Section PS 3410..049 The existence of a public sector entity s legislation containing details of the public sector entity s policy in relation to a particular program, such as taxation is not a past transaction or event that gives rise to control of an economic resource until the taxable event occurs. For guidance on how to account for tax revenue, refer to TAX REVENUE, Section PS 3510..050 The past transaction or event giving rise to control of an economic resource must have occurred by the financial statement date. Legislation having retroactive application cannot create a past transaction or event. Any economic resources related to that legislation would be accounted for in the current period, not in the period of the effective date of the legislation. FUTURE ECONOMIC BENEFITS.051 FINANCIAL STATEMENT CONCEPTS, paragraph PS 1000.36, states that a future economic benefit entails capacity, singly or in combination with other assets, to provide future net cash flows, or to provide goods and services. This guidance is limited and in need of enhancement in order to further explain what is meant by future economic benefits and how they may arise in the public sector. 10 STATEMENT OF PRINCIPLES AUGUST 2013
.052 The existing guidance contains a notion of a capacity to provide goods and services, which is commonly referred to as service potential. In building the proposed guidance, PSAB considered replacing the current wording of capacity to provide goods and services with a defined term service potential. It was thought, however, that such a change may not add value, is circuitous and may cause confusion among users. Therefore, it was proposed to clearly explain what is meant by such capacity rather than replacing the term and defining it with words that already exist in the guidance on future economic benefits..053 In their definition of assets some standard setters differentiate between future economic benefits and service potential. 4 Economic benefits involve inflow of cash or cash equivalents, or a capacity to reduce cash outflows, while service potential embodies a capacity to provide goods and services. The private sector standard setters generally use future economic benefits to mean the capacity to provide net cash inflows unless their guidance applies to not-for-profit organizations, where provision of goods and services is key. 5 Overall, regardless of the approach used, standard setters agree that the benefits that flow from the assets include the capacity to provide goods and services, to provide cash inflows or to reduce cash outflows..054 GASB, in its definition of assets, refers to present service capacity, rather than future economic benefits, which is defined as existing capacity to enable the government to provide services, which in turn enables the government to fulfill its mission. Buildings or artifacts of historical significance are provided as examples of assets with present service capacity that can be directly used in that their preservation and continued existence is a service to society..055 Other standard setters also provide additional guidance as to how the future economic benefits embodied in an asset may flow to the entity. Examples include ability to use an asset: (a) singly or in combination with other assets in the production of goods or services; (b) to exchange for other assets; (c) to settle a liability; or (d) to distribute to the owners of the entity. Proposed guidance.056 Assets embody future economic benefits that allow public sector entities to achieve their objectives. The future economic benefit embodied in an asset is a capacity, singly or in combination with other assets, to provide goods and services, to provide future net cash inflows or to reduce cash outflows. 4 Standard setters reviewed that address this topic include: AASB, FASAB, FASB, IASB, IPSASB. 5 Standard setters reviewed that address this topic include: AcSB, GASB, UK ASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 11
.057 Generally, public sector entities provide public goods and services, and redistribute wealth. As some goods and services are provided at no charge or for a reduced fee, the provision of goods and services may not contribute to the net cash inflows of the entity. Consequently, public sector entities rely on taxation, donations and borrowing to finance their operations..058 Assets of a public sector entity embody the capacity to provide goods and services. For example, assets, such as buses, are used to provide transportation services to the public. Hospital buildings and medical equipment are used to provide health care services. Parks, art and historic treasures provide recreational, educational and research opportunities to the public. Water treatment plants provide goods, such as potable water. Such assets benefit public sector entities as they assist in achieving the entity s primary objective of providing public goods and services..059 Although profit is not the principal objective of public sector entities, the future economic benefits embodied in an asset may also be in the form of generating future net cash inflows. For example, net cash inflows could be generated from the exchange or sale of a resource for cash or cash equivalents, or from holding cash or investments. Also, some public sector resources generate net cash inflows because they have user fees associated with them..060 Benefits in the form of net cash inflows relate to resources, such as cash, loans, receivables, inventory for resale and portfolio investments. Net cash inflows and, consequently, cash benefit the public sector entity as cash can be used to purchase or to provide goods and services, redistribute wealth or settle liabilities..061 The future economic benefits may also take the form of a capacity to reduce cash outflows. For example, this may be the case when betterment of the tangible capital asset reduces the cost of production..062 The essence of an asset is its future economic benefit. There is a close association between incurring a cost and the generation of an asset. However, not all costs result in a future economic benefit. For example, costs incurred to maintain the current service capacity of an asset do not provide a future economic benefit. Also, a public sector entity may obtain an asset without incurring costs. For example, items that have been donated to the public sector entity may provide the public sector entity with future economic benefits and, hence, satisfy the definition of assets. DISCLOSURE.063 The PSA Handbook provides disclosure requirements for recognized assets. It also provides disclosure requirements for some unrecognized assets. However, it does not provide general disclosure requirements for all unrecognized assets. 12 STATEMENT OF PRINCIPLES AUGUST 2013
.064 On the other hand, LIABILITIES, Section PS 3200, provides a general disclosure requirement for all unrecognized liabilities. For items that meet the definition of a liability but cannot be reasonably measured, Section PS 3200 requires that the nature of the liability be disclosed in the notes together with the reason(s) why a reasonable estimate cannot be made of the amount involved. It would appear that such a general disclosure requirement would apply to all unrecognized assets as well..065 The disclosure guidance in the Section on assets will differ from that in LIABILITIES, Section PS 3200. This is due to the fact that FINANCIAL STATEMENT CONCEPTS, Section PS 1000, specifically excludes items, such as intangibles from recognition whether they can be measured or not (refer to paragraph.004). As a result, the reason for not recognizing an asset is not always an inability to measure it..066 There are varying requirements among standard setters with regard to disclosure of unrecognized assets. Proposed guidance.067 An economic resource may meet the definition of an asset. However; (a) it is not capable of being recognized in financial statements because an appropriate basis of measurement and a reasonable estimate of the amount involved cannot be made; or (b) other Sections of the PSA Handbook prohibit its recognition..068 For unrecognized assets, disclosing the nature of the asset provides information about the economic resources available to the public sector entity. Principle 1 Information about the nature of assets that are not recognized should be disclosed in notes together with the reason(s) why. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 13
PART II CONTINGENT ASSETS.069 FINANCIAL STATEMENT PRESENTATION, paragraph PS 1201.071, provides a definition of contingencies and some guidance on contingent assets: Contingencies are the result of existing conditions or situations involving uncertainty that will ultimately be resolved when one or more future events occur or fail to occur. Resolution of the uncertainty may confirm the acquisition of an asset, the reduction of a liability, the loss or impairment of an asset, or the incurrence of a liability. Contingencies result from such matters as pending or threatened litigation, guarantees of the indebtedness of others, indemnities and provisions related to insurance programs. They also include grants or contributions that are recoverable if certain future events occur or fail to occur..070 The existing guidance also clarifies that the mere fact that an estimate is involved does not, in and of itself, constitute the type of uncertainty that characterizes a contingent asset..071 PSAB s existing guidance only provides a general definition of contingencies and limited guidance on contingent assets. Including a definition of contingent assets and an explanation of what is meant by the terms included in the definition would provide users with an understanding of what constitutes a contingent asset and assist them in evaluating whether a contingent asset exists..072 Other standard setters define a contingent asset as a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity. 6.073 Other standard setters also note that contingent assets usually arise from unplanned or other unexpected events that are not wholly within the control of the entity and give rise to the possibility of an inflow of economic benefits or service potential to the entity. 7.074 As limited guidance on contingent assets exists and to ensure consistency within the PSA Handbook, CONTINGENT LIABILITIES, Section PS 3300, was also considered in drafting the proposed guidance on contingent assets. Section PS 3300 provides the characteristics of contingent liabilities and further explains what is meant by those characteristics. 6 Other standard setters reviewed that address this topic include: AASB, IASB, IPSASB, NZ FRSB, SA ASB, UK ASB. 7 Other standard setters reviewed that address this topic include: AASB, IASB, IPSASB, NZ FRSB, SA ASB, UK ASB. 14 STATEMENT OF PRINCIPLES AUGUST 2013
CHARACTERISTICS OF CONTINGENT ASSETS Proposed guidance.075 Contingent assets are distinct from assets as they are characterized by the uncertainty related to the existence of an asset at the financial statement date..076 Contingent assets usually arise from unplanned or other unexpected events that lead to an existing condition or situation the outcome of which is uncertain. The outcome or resolution of the condition or situation after the financial statement date will confirm whether an asset exists..077 Two basic characteristics of contingent assets are: (a) there must be an existing condition or situation that is unresolved at the financial statement date; and (b) there must be an expected future event that will resolve the uncertainty as to whether an asset exists..078 The mere fact that an estimate of an amount is involved (measurement uncertainty) does not, in and of itself, constitute the type of uncertainty that characterizes a contingent asset. For example, even though there may be measurement uncertainty related to income tax receivable, there is nothing uncertain about the fact that this asset exists. Any uncertainty is related solely to the amount thereof. Existing condition or situation.079 For a contingent asset to be present, there usually is an unplanned or other unexpected event leading to an existing condition or situation where the evidence indicates that a public sector entity may have an asset. For example, a public sector entity may have incurred an unexpected loss and there is sufficient evidence for potential recovery. The potential for recovery constitutes the existing condition or situation giving rise to a possible asset. It is a possible asset because of the uncertainty around recovery and it is only a future event that will confirm whether the public sector entity has an asset..080 A public sector entity may have entered into a contract before the financial statement date to purchase land after the year end. This is not a contingent asset because there is no unresolved condition or situation that would indicate that the entity has an asset at year end. The land purchase is a future transaction..081 Passing legislation that has retroactive application after the financial statement date cannot create an existing condition or situation at the financial statement date. Further, elected or public sector entity officials may announce public sector entity intentions in a period following the financial statement date but before the completion of the financial statements. If a condition or situation did not exist at the date of the financial statements, there is no contingent asset. However, there may be a subsequent event (see SUBSEQUENT EVENTS, Section PS 2400). ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 15
Confirming future event.082 For a contingent asset to exist, there must also be an expected confirming future event(s) that will resolve the uncertainty. The expected confirming future event provides additional information as to whether a public sector entity has an asset at the financial statement date. The confirming future event does not create an asset it only proves or disproves its existence at the financial statement date..083 The future confirming event cannot be wholly within the control of the public sector entity. When a public sector entity is involved in a lawsuit, the future confirming event (the resolution of the lawsuit) is not within the control of that public sector entity. Proposed definition Contingent assets are possible resources that may result in future economic benefits arising from existing conditions or situations involving uncertainty. That uncertainty will ultimately be resolved when one or more future events not wholly within the public sector entity's control occurs or fails to occur. Resolution of the uncertainty will confirm the existence or non-existence of an asset. EXISTENCE UNCERTAINTY.084 Contingent assets are characterized by uncertainty as to the existence of an asset at the financial statement date. The PSA Handbook in the CONTINGENT LIABILITIES, Section PS 3300, deals with existence uncertainty by assessing the probability of a future event occurring or not occurring. The question arises, should this approach also be used for contingent assets or should an alternative approach be considered. Alternatives considered.085 There are two main approaches to addressing existence uncertainty: (a) standardized threshold criteria; and (b) use of all available evidence to make neutral judgments about the element s existence..086 Under the first approach, determining whether an asset exists at the financial statement date depends on an assessment of the probability of a future event confirming that an asset existed or did not exist at the financial statement date. Such assessment requires the use of judgment by those responsible for preparing the financial statements..087 Clearly, when an asset has been received, there is no uncertainty about its existence. However, there can be situations where there is uncertainty as to whether the asset exists at the financial statement date. In these situations, the uncertainty may only be resolved by a future event occurring that will confirm either that the asset existed or it did not. Uncertainty relating to the occurrence 16 STATEMENT OF PRINCIPLES AUGUST 2013
or non-occurrence of the future event(s) can be expressed by a range of probabilities or thresholds. The degrees of probability that a future event will occur are commonly described as: (a) likely, more likely than not, probable the probability of the occurrence (or non-occurrence) of the future event(s) is high; (b) unlikely, less likely than not, not probable, remote the probability of the occurrence (or non-occurrence) of the future event(s) is slight; and (c) not determinable the probability of the occurrence (or non-occurrence) of the future event(s) cannot be determined..088 The advantage of this approach is that it uses understandable, general threshold criteria that act as filters, screening out items that have low or even remote likelihood of occurrence. The standardized threshold approach is currently used by other standard setters. 8.089 In its Conceptual Framework Exposure Draft 2, IPSASB considered whether, in dealing with existence uncertainty, a standardized threshold criteria should be adopted, or whether all available evidence should be used to make neutral judgments about an element s existence. IPSASB formed a view that while the adoption of thresholds for recognition purposes may produce information that is understandable, such an approach risks omitting information that is relevant and faithfully representative. This is because it disregards items that are below such thresholds, perhaps by very small margins, but which will in all other ways meet the definition of an element. Therefore, IPSASB concluded that, on balance, all available evidence should be assessed in determining whether an element exists..090 PSAB is of the view that both approaches require neutrality in judgment as to whether an asset exists at the financial statement date and both would produce results that meet the qualitative characteristics. However, the first approach is more pragmatic and simpler for users to apply. Providing basic guidance as to when those thresholds have been met would offer a more consistent basis for users than would the evidence-based approach. Proposed guidance.091 The determination of whether an asset exists at the financial statement date depends on an assessment of the probability of a future event occurring, or not occurring, confirming that an asset existed at the financial statement date. This probability can be expressed by the following: (a) likely the probability of the occurrence (or non-occurrence) of the future event(s) is high; (b) unlikely the probability of the occurrence (or non-occurrence) of the future event(s) is slight; and 8 Other standard setters reviewed that address this topic include: AASB, AcSB, FASAB, FASB, GASB, IASB, IPSASB, NZ FRSB, SA ASB, UK ASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 17
(c) not determinable the probability of the occurrence (or non-occurrence) of the future event(s) cannot be determined..092 Assessing the likelihood of the future confirming event occurring, including estimating its financial effects, is a matter for judgment by those responsible for preparing the financial statements. In identifying contingent assets and determining their amount, consideration would be given to all information available prior to completion of the financial statements, supplemented by experience in similar transactions and, in some cases, reports from independent experts. DISCLOSURE VS RECOGNITION.093 The existing guidance on contingent assets, as provided in FINANCIAL STATEMENT PRESENTATION, paragraph PS 1201.072, requires only disclosure of material contingent assets at the end of the accounting period. It does not provide any further guidance as to what should be disclosed..094 On the other hand, CONTINGENT LIABILITIES, Section PS 3300, requires recognition of contingent liabilities when it is likely that a future event will confirm that a liability has been incurred at the date of the financial statements. The question arises whether contingent assets should continue to be just disclosed or recognized similarly to contingent liabilities. When disclosure or recognition would be appropriate also needs to be addressed. Alternatives considered.095 In assessing the alternatives for reporting of contingent assets the following options have been considered: (a) disclosure; and (b) recognition..096 There is general support among standard setters to disclose contingent assets when the probability of the confirming future event occurring is high (probable, likely). 9 Contingent assets are not recognized as there is a concern that recognition of contingent assets would result in recognizing revenue that may never be realized..097 Standard setters that do not provide guidance on contingent assets do offer guidance for contingent gains. 10 That guidance also states that contingent gains shall not be recognized and requires disclosure of contingent gains when the occurrence of the future confirming event is high (likely) or when contingencies might result in a gain. 9 The standard setters reviewed that address this topic include: AASB, AcSB (Part I) IASB, IPSASB, NZ FRSB, PSAB, SA ASB, UK ASB. 10 The standard setters reviewed that address this topic include: AcSB (Part II) and FASB, GASB. 18 STATEMENT OF PRINCIPLES AUGUST 2013
.098 Although some standard setters note that contingent assets should not be recognized, they state that: when realization of revenue is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate. 11 Those same standard setters, unlike PSAB, note that contingent liabilities should not be recognized. However, they allow for recognition of a provision when an outflow of resources embodying economic benefits or service potential is probable (likely). Therefore, although those standard setters state that contingent assets and contingent liabilities should not be recognized, they effectively allow for recognition of contingent assets and contingent liabilities as assets and liabilities when certain criteria is met. Whether a contingent asset or contingent liability is recognized as an asset or liability or as a contingent asset or contingent liability, it still increases an asset or liability account and, thus, the impact on the financial statements is the same regardless of the approach taken..099 The function of financial statements is the communication of information to users. To fulfill this function effectively, the information must embody certain essential characteristics. These include reliability, relevance, comparability and understandability. For that reason, in arriving at the appropriate alternative for reporting of contingent assets, it is important to consider the qualitative characteristics that the information presented in the financial statements should have..100 According to FINANCIAL STATEMENT CONCEPTS, Section PS 1000, one of the traits of reliable information is conservatism. Conservatism conveys that when uncertainty exists, assets, revenue and gains should not be overstated, and liabilities, expenses and losses should not be understated. Practically, this has been interpreted to mean that a higher evidence level is required for an asset than for a liability in order for those elements to be recognized in the financial statements. However, conservatism does not encompass the deliberate understatement of assets and revenue, or the deliberate overstatement of liabilities and expenses..101 FINANCIAL STATEMENT CONCEPTS, Section PS 1000, also provides that reliable information possesses the characteristic of neutrality. Information is neutral when it is free from bias that would lead users towards making decisions that are influenced by the way information is measured or presented. Requiring that contingent assets be disclosed while contingent liabilities are recognized may introduce bias into financial statements and, hence, lack neutrality. Such bias is contrary to the qualitative characteristic of representational faithfulness, which requires that transactions and events affecting the entity are presented in financial statements in a manner that is in agreement with the actual underlying transactions and events. Biased information, which does not faithfully represent the substance of the transaction or event, inhibits understanding, evaluation and 11 The standard setters reviewed that address this topic include: AASB, AcSB (Part I), IASB, IPSASB, NZ FRSB, SA ASB, UK ASB. ASSETS, CONTINGENT ASSETS AND CONTRACTUAL RIGHTS 19