Quantitative Examples: Change from Going Concern to Liquidation Basis for Liabilities Under IAS 37

Introduction

Under IAS 37, the recognition and measurement of liabilities can significantly change when an entity transitions from a going concern to a liquidation basis. This report provides three quantitative examples to illustrate how the recognition and measurement of liabilities change during this transition.

Example 1: Long-Term Loan

Going Concern Basis

A company has a long-term loan of R2,000,000 with an annual interest rate of 5%, payable over 10 years. The loan is initially recognized at fair value and subsequently measured at amortized cost. The company pays interest annually.

Calculation (Going Concern):

• Annual Interest Expense = Principal Amount * Interest Rate

• Annual Interest Expense = R2,000,000 * 5% = R100,000

• Present Value of Remaining Loan Payments (Discounted at the loan’s effective interest rate):

Given the loan is to be paid over 10 years, using the present value formula for annuities, the carrying amount after 3 years (with annual payments) can be calculated.

Liquidation Basis

Upon deciding to liquidate, the company needs to settle the loan immediately. The early repayment penalty is 2% of the outstanding principal.

Calculation (Liquidation Basis):

• Outstanding Principal Amount = R2,000,000 (assuming no principal payments yet, for simplicity)

• Early Repayment Penalty = Outstanding Principal * Penalty Rate

• Early Repayment Penalty = R2,000,000 * 2% = R40,000

• Total Settlement Amount = Outstanding Principal + Early Repayment Penalty

• Total Settlement Amount = R2,000,000 + R40,000 = R2,040,000

Summary

• Carrying Value (Going Concern): Present value of remaining payments (e.g., R1,800,000 after discounting)

• Liquidation Value: R2,040,000

Adjustment Needed: Increase in liability recognition by R240,000 (from R1,800,000 to R2,040,000).

Example 2: Provision for Warranty

Going Concern Basis

A company provides a two-year warranty on products sold, estimating that 5% of products sold will require repairs costing R500 per unit. In the current year, 10,000 units are sold.

Calculation (Going Concern):

• Estimated Warranty Claims = Units Sold * Percentage of Claims * Cost per Unit

• Estimated Warranty Claims = 10,000 * 5% * R500 = R250,000

Liquidation Basis

The company decides to liquidate, and anticipates all warranty claims will need to be settled within the liquidation period. Additionally, accelerated settlement increases the estimated cost per claim to R600.

Calculation (Liquidation Basis):

• Estimated Warranty Claims (Liquidation) = Units Sold * Percentage of Claims * Increased Cost per Unit

• Estimated Warranty Claims (Liquidation) = 10,000 * 5% * R600 = R300,000

Summary

• Carrying Value (Going Concern): R250,000

• Liquidation Value: R300,000

Adjustment Needed: Increase in liability recognition by R50,000 (from R250,000 to R300,000).

Example 3: Employee Severance Pay

Going Concern Basis

A company has an ongoing obligation to provide severance pay to employees upon termination. The present value of the expected obligation is estimated at R500,000 based on historical turnover rates and current salary levels.

Calculation (Going Concern):

• Present Value of Severance Obligation = R500,000

Liquidation Basis

The company decides to liquidate, and all employees will be terminated. The severance pay per employee increases due to the immediate and large-scale layoffs. The total severance pay obligation is now estimated to be R700,000.

Calculation (Liquidation Basis):

• Total Severance Pay Obligation = R700,000

Summary

• Carrying Value (Going Concern): R500,000

• Liquidation Value: R700,000

Adjustment Needed: Increase in liability recognition by R200,000 (from R500,000 to R700,000).

Conclusion

The transition from a going concern basis to a liquidation basis under IAS 37 significantly impacts the recognition and measurement of liabilities. The examples provided demonstrate how liabilities are adjusted to reflect their expected settlement amounts during liquidation, including any penalties, increased costs, or accelerated settlement obligations. These adjustments ensure that financial statements provide a true and fair view of an entity’s financial position during liquidation, complying with the principles of IAS 37.

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