Embracing uncertainties
Credit to Author: AIRA REGINA S. ARBOLEDA| Date: Thu, 24 Jan 2019 16:16:13 +0000
Change is constant and endless opportunities come and go every day, and in a heartbeat. It may seem like a lot to take and we acknowledge that we really cannot control all of it. Hence, we plan hard for those circumstances we can anticipate. In the process however, how well do we understand that anticipating future uncertainties is equally important?
Recognizing assets (or liabilities) in accounting are triggered by past events that materialize, resulting in eventual inflow (or outflow) of resources in the organization. But the real beauty of accounting is that creation of assets (or liabilities) is not confined within the walls of certainty.
So we ask, when the uncertain happens, how do we account for it? Or do we actually account for them at all?
Let’s look into some stories to see if there are valid assets or liabilities arising from uncertainties.
Restructuring
Pink and Purple Co. (PPC) is a small cosmetic manufacturer of cream foundation, lipstick, and balms. Each segment has weighing and pre-mixing lines for each of the available shades of its products. Workers who man these production areas weigh all ingredients such as wax, pigments, and moisturizers, according to PPC’s secret
formula, and initiate a pre-mix before the start of the manufacturing process.
It’s been quite some time that PPC has outsourced its machineries from external providers to automate this sub-process. Benefits include decreased wastage, reduced production time of six hours from 10 hours, and more importantly, lower future costs. PPC planned that in about 60 days, 30 affected employees will eventually exit and be replaced by the automated sub-process. PPC also estimates that a package of twice the employees’ compensation and benefits is a fair severance offer.
Given the very promising returns and future benefits to the company, its board of directors approved the project plan. Then, the restructuring plan was communicated to the employees of PPC in one of their town hall meetings.
International Accounting Standards (IAS) 37 defines restructuring as a program planned and controlled by management, and materially changes either a) the scope of the business undertaken by an entity, or b) the manner in which that business is conducted, similar to that of PPC. At this point, given the actions already taken by PPC, recognition of provision (or a liability) in PPC’s balance sheet becomes valid.
But how much liability can PPC recognize? Restructuring provision is measured to include only direct expenses attributable to the exercise. That means the provision will mainly consist of the total amount of expected severance package for affected employees. Restructuring provision does not include investment cost for new machineries to be deployed in production.
Reimbursements
Ryley is a business owner of Wipe Co., a manufacturer of toilet papers for household and industrial distribution. Her products range from facial tissues, bathroom tissue rolls, to paper towels. Right before the year ended, a typhoon hit the metro and the manufacturing facility got flooded. Luckily, most of the machineries are located at the far end and elevated part of the facility. However, the smaller packaging machineries and holding areas for the finished goods were submerged in water.
Ryley remembered that Wipe Co.’s insurance policy covers claims for incidents like this. After clean-up, some minor repairs, and segregation of damaged toilet papers for disposal, Ryley immediately retrieved the facility’s insurance policy. She learned that the policy coverage is for P2 million, and hence recorded a contingent asset and a gain prior to year-end closing of books.
In the loss declaration that she filed with the insurer in December 2018, claims for flood loss include P800,000 net carrying value of damaged packaging machineries and P700,000 worth of toilet paper packs that have gone wet and could no longer be sold. With all required documentation and supporting papers now submitted to the insurer, Ryley is complacent that the claims will be granted. She just has to wait for the insurer’s final confirmation.
Was Ryley able to capture this unfortunate incident correctly in the entries in the balance sheet? The answer is no.
IAS 37 states that an entity should recognize an obligation (or loss, in the case of Wipe Co.) before recognizing a related reimbursement. This is because Wipe Co. has to recognize first an outflow that is probable.
In January 2019, the insurer evaluated Wipe Co.’s claim and soon after issued an order to release the payment for the sum of P1.5 million, or the combined amount of losses.
Does Wipe Co. have a valid asset arising from the insurance claim? It depends.
Because Ryley has completed and submitted all required documentation to the insurer before year-end, the subsequent acknowledgement from the insurer has now made the reimbursement virtually certain. This becomes an adjusting event, allowing the recognition of an asset, but only up to the extent of the recognized liability (or loss), which is P1.5 million. Had she forgotten to file for the claim or the documents were incomplete, there would be no valid asset to recognize by year-end.
As playfully illustrated, the term “contingent” for assets and liabilities is not recognized outright because their existence will be confirmed only by the happening (or not) of future events not wholly within our control. This will answer how we will be accounting for these uncertainties.
We plan on things and try to micromanage our activities because that is more comfortable, predictable, and less dramatic.
While recognizing these contingencies as results of uncertain events that have transpired, for PPC and Wipe Co., it is a realization at the same time that embracing uncertainties keeps us grounded and resilient.
Dealing well with what’s certain is one, but dealing better with uncertainties is another.
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Aira Regina S. Arboleda is an Assurance Director of Isla Lipana & Co., a member firm of the PwC network. For more information, please email markets@ph.pwc.com. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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