A constructive obligation is an obligation to pay that arises out of conduct and intent rather than a contract. A constructive obligation may need to be shown on the balance sheet as a liability.
A constructive obligation typically occurs from past conduct. It exists when an entity (e.g. the company whose accounts are being drawn up) has no realistic alternative to fulfilling an obligation, even if it is not legally enforceable. Under IFRS, a constructive obligation must be accounted for as a liability if it meets other criteria that require recording as a liability: the degree of certainty involved, whether the entity has any discretion to avoid the liability, etc.
Even if uncertain, a constructive obligation may need to be disclosed as a contingent liability.
Common examples of constructive obligations that are not legally binding include:
- retirement benefits paid in excess of strict legal obligations (which cannot be reneged on without creating retention and morale problems),
- retailers' returns policies that are more generous than legal or contractual requirements (stopping such a practice would damage the retailers reputation),
- restructuring costs, once plans have been finalised and communicated as such to those affected.
In some circumstances, a constructive obligation can become legally enforceable, which makes it slightly clearer that it needs to be accounted for — but it still needs to meet the other criteria for recording a liability.