The subject of this discussion is when to recognise an accrual for bonuses and when a provision.
As per the requirements of the Conceptual Framework and IAS 37 – Provisions, Contingent Liabilities and Contingent Assets of the International Financial Reporting Standards (IFRS), entities have to recognise a liability in the financial statements when all of the following conditions are met:
There is a present obligation
The obligation arose from a past event
It is probable that an outflow of resources embodying economic benefits will result from the settlement of the obligation
The amount at which the settlement will take place can be measured reliably.
A provision on the other hand should be recognised if the above conditions for a liability are met, but there is uncertainty regarding the timing or amount of the liability.
When considering whether a bonus obligation should be recognised as a liability (an accrual) or as a provision the following needs to be considered:
Does the entity have a legal or constructive obligation to pay the bonus?
In most cases, the employee has a right to receive a 13th cheque or a performance based bonus as per the employment contract. This will result in a legal obligation.
Bonuses that are not stipulated in employment contracts do not give rise to a legal obligation, but may result in a constructive obligation. If the entity for example has a history of paying bonuses every year and by doing so created a valid expectation that they will continue to pay annual bonuses, they have a constructive obligation to pay bonuses.
If the performance measurement date is not at year end, management will most likely have to account for a provision at year end.
Was there a past event that gave rise to the obligation?
In the case of a 13th cheque this is easy to determine if assumed that the bonus accrues on a pro-rata basis as services are rendered by the employees. If bonuses do not accrue on a pro-rata basis management will have to estimate the number of employees that will still be employed at the bonus payment date and a provision will have to be recognised. If bonuses are paid on an ad-hoc basis an obligation might not exist at all.
Is it probable that the settlement of the obligation will lead to an outflow of economic benefits?
The payment of a bonus will lead to an outflow of economic benefits and therefore it needs to be considered whether the outflow of economic benefits is probable or not. This might be difficult to determine when the entity pays performance based bonuses as opposed to a 13th cheque. Management will have to make an estimate as to the amount of the bonus and recognise it as provision.
Can the amount of the obligation be measured reliably?
The amount of a 13th cheque bonus is easy to determine but estimates will be necessary to determine the amount of a performance based bonus which will most likely result in a provision being recognised.
In conclusion, first consider whether a bonus obligation meets the definition of a liability before considering whether it should be recognised as a liability or a provision.
Senior Audit Manager, Tshwane