You might have heard a joke regarding two accountants applying for job who were asked to produce a net profit figure based on provided data. The first accountant calculated the net profit figures as $12m where as second one asked what you want figures to be.
In the past, when there was no standard guidance, there used to be practices of booking provisions when there was high profit and writing it back in next years when profit was low in order to smooth the profits.
This was addressed in 1998 when formerly IASC (present IASB) develop the new standard for recognizing provisions IAS 37.
Now provision is recognized if it meets ALL the following criteria (ROT):
R Reasonably reliable estimate: There must be a reasonable estimate of the amount of provision.
O Obligation: There must be present legal or constructive obligation as a result of past obligating event.
T Transfer: Cash or other economic benefits is expected to transfer from the entity.
If you are unsure about a particular situation whether to book a provision or not, ask a question – whether the obligation can be avoided by some future actions? If you can avoid, no provision can be booked.
For example, let’s say SSBGM group provides free warranty service for any faulty Mac Book at the point of sale, then there is a present obligation. This cannot be avoided by any actions. So, the group should book warranty provisions based on past trends.
Let’s take the above example for understanding the measurement of provisions:
Lets assume based on past trends, Provisons for warranty is $2m
Booking of provisions:
Debit Provision expenses (p/l) $2m
Credit Warranty provision liability (SOFP) $2m
I hope you get some basic ideas in applying the IAS 37 provisions. This is relevant to ACCA paper Financial Reporting (FR) and only to some extent Strategic Business Reporting (SBR) as SBR tend to focus on more complicated provisions. The complicated provisions issue relevant to SBR will be dealt with soon in the next article as dealing it here will be too long. There are other areas as well in provisions such as what to do with utilization of these provisions, unwinding of discount if it is for more than 12 months by the method of present value discounting, reimbursement of expenditures and other areas in IAS 37 such as Contingent liabilities and Contingent assets which all will be dealt with in the next article.
Written by a member of CCA Management Team.
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