Monday 23 May 2022
When working with finalist accountants preparing for upcoming exams, one question I invariably ask of them goes something like this; "So, which of the accounting standards refers to an event being highly probable"?
The question is asked knowing that the response, often rushed out, will typically be… "IAS 37!".
Which. Would. Be. Wrong.
IAS 37, Provisions, Contingencies and Contingent Assets refers to ‘probable’, as well as ‘possible’ and ‘remote’ and ‘virtually certain’. Move along, there is no ‘highly probable’ to be seen here.
Now, whilst it might not give me great pleasure in stating the incorrectness of the answer to my quiz, what the questioning does do is,
- reinforce the need to be aware of how different standards have different tolerances, and
- emphasize that so much of what we do as business reporters is built upon the exercise of professional judgement. What is the difference between probable, and highly probable? There must be a difference, otherwise all forms of ‘probable’ would be the same. And, how is the extent of that difference determined? Presumably, through the exercise of judgement.
Whilst not appearing within the list of defined terms, IAS 37 is still clear as to what probable means in relation to its recognition criteria,
"For the purpose of this standard, an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not".
Often, this characteristic of ‘more likely than not to occur’ is thought of in terms of a % of likelihood, a short-cut which might not be as efficient as it first appears. Thus, for some, probable always represents "more than 50%". This makes it sound a little easier to understand, but has a fundamental weakness on two parts, namely,
- no ‘bright-line’ percentages are to be found within IAS 37; clearly there must be a reason for that, and
- by implication, 75% is the same "more than 50%" as 51%, 60%, 80% etc. etc. - when clearly it isn’t.
Step forward please highly probable. Application of this term first appears in IFRS 5, Non-current Assets Held for Sale and Discontinued Operations;
"An entity shall classify a non‑current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable".
This term is within IFRS 5’s defined terms, thus;
"Highly probable is significantly more likely than probable".
Hey, thanks. That’s cleared that one up!
Like a film director who makes an epic, disappears from the scene for a decade before returning with the ‘highly anticipated’ comeback, highly probable did take some time for its second appearance. We move along to IFRS 15, Revenue from Contracts with Customers, and the challenges associated with,
- determining variable consideration within the transaction price of the contract, and
- assessing the degree to which any variable consideration identified should be constrained.
As per the standard,
"An entity shall include in the transaction price some or all of an amount of variable consideration only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved".
IFRS 15 does not specifically include a definition of highly probable within it terms. Thus, we must surely presume that once highly probable is significantly more likely than probable (IFRS 5) it is always significantly more likely than probable (IFRS 15 et al), however we determine it.
IFRS 15 does assist by going on to say,
"in assessing whether it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur once the uncertainty related to the variable consideration is subsequently resolved, an entity shall consider both the likelihood and the magnitude of the revenue reversal".
All of this helps – to a degree. Again though, no percentages, no bright lines. Of course not. A principles-based reporting system is based around the viewpoint and assessment of the professional. Arguably it’s why business reporting is often described as an art form rather than a science. Art has nuances, shades, degrees. For us, let’s call those characteristics judgement. Thus, a knock-on question from the above, once we’re happy with probable v highly probable is "what is meant by a ‘significant reversal’?"
That will be the next question for my finalists… Am I likely to receive a range of answers? Including "significant is more than 50%"?
Over the coming months, both in-person and online, IASeminars will offer a range of courses to provide you with a greater insight into the application and relevance of key corporate reporting terms such as probable, highly probable, significant. Some courses are standard specific whilst others, including our flagship IFRS Masterclass event, provide an intensive workout across the published guidance for recognition, measurement, and disclosure.
Other concepts such as materiality are important both for traditional financial reporting and for the reporting of Environmental, Social and Governance (ESG) issues. As the International Sustainability Standards Board continues with its work on developing baseline globally accepted ESG standards, an understanding of materiality in this arena is becoming increasingly important. IASeminars regularly offers to an online introductory course – ESG, Why You Need to Care – where materiality and application of the ‘materiality lens’ is introduced. And new for the latter part of the year is an in-person version of this course!
Finally, if you’re involved in US GAAP then you’ll want to know that for the FASB the term probable has a different meaning again - "the future event or events are likely to occur."
We have US GAAP training available too, that is more than likely going to occur. We hope to see you soon.