Technical20

A provision is a liability that is of

uncertain timing or amount, to be

settled by the transfer of economic

A contingent liability is: A possible obligation arising

from past events whose existence

-

currence of one or more uncertain

future events not wholly within the

entity’s control, or.

A present obligation that arises

from past events but is not recog-

nised because it is not probable

will be required to settle the obli-

gation or because the amount of

the obligation cannot be measured

A contingent asset is a possible as-

set arising from past events whose

by the occurrence of one or more

uncertain future events not wholly

within the entity’s control.

Recognition of a ProvisionFRS 12 and IAS 37 are identical in

nature and contain 3 criteria which

must be met before a provision

statements. These criteria are:

ProvisionsProvisions, contingent liabilities and contingent assets can often cause confusion among accountants, particularly in de-ciphering when to recognise a provision or disclosing a contin-gency. This article looks at the provisions laid down in FRS 12 and IAS 37 ‘Provisions, Contingent Liabilities and Contingent

and discusses when and when not to recognise a provision.

The entity has a present obliga-

tion (legal or constructive) as a

result of a past event.

of resources embodying economic

the obligation.

A reliable estimate can be made

of the amount of the obligation.

Figure 1Company A has decided to close

its international branches and

consolidate its international opera-

tions into its domestic operations.

It puts a full announcement to

the international staff out on 20

November 2009. It has calculated

the redundancy provisions and has

included the redundancy provision

year ended 31 December 2009.

Company A has an obligation

as a result of a past event: the

announcement on 20 November

2009 of the redundancies.

It is probable (i.e. more likely than

Steve Collings, FMAAT FCCAis audit and technical director at Leavitt Walmsley Associates and a freelance technical writer.

Mar/Apr 2011

Technical20 21globalaccountantmagazine.com

the obligation: the redundancy

payments.

A reliable estimate can be made of

the amount of the obligation: the

redundancy calculations.

Company A has therefore met all

three criteria laid down in FRS 12

/ IAS 37 and therefore a provision

can be made.

Contingent LiabilitiesContingent liabilities are not recog-

Instead contingent liabilities are

disclosed within the notes to the

Under FRS 12 and IAS 37, a contingent liability is:

A possible obligation that

arises from past events and whose

by the occurrence or non-occur-

rence of one or more

uncertain future events

not wholly within the

control of the entity, or.

A present obliga-

tion that arises from

past events but is not

recognised because:

it is not probable

resources embodying

be required to settle

the obligation; or

the amount of the

obligation cannot be

measured with suf-

Figure 2Alicia Limited has made a provi-

sion for damages amounting to

for the year ended 31 December

2009 in respect of a legal claim

brought against the company by

one of its customers. The legal

advisers have advised that at the

reporting date they are uncertain

as to the potential outcome of the

case.

Alicia Limited should not recognise

a provision for damages of $10,000

because it is not ‘probable’ that

required to settle the case. The

legal advisers are not sure as to the

outcome of the case. In this case,

disclosure of a contingent liability

-

ments should be made.

Contingent AssetsContingent assets should only ever

be recognised if it is virtually cer-

tain that an entity will realise the

contingent asset.

Summary

Contingent Liabilities

There is a present ob-

ligation that probably

requires a transfer of

settle.

There is a possible obligation

or a present obligation that

may, but may not, require a

to settle.

There is a possible obliga-

tion or a present obligation

where the likelihood of a

is remote.

A provision is required and disclosures are required for the provi-sion.

No provision is recognised but disclosure as a contingent liability is required.

No provision is recognised and no disclosure is required.

Contingent Assets

certain.

is probable but not virtually

certain.

The asset is not contin-gent, thus provision should be made.

No asset is recognised but disclosures are made in the notes.

No asset is recognised and no disclosure is made.

Technical22

-

Where dividends and bonus provi-

sions are concerned, confusion

often lies in when it is appropri-

ate to recognise them. HMRC are

also particularly keen on practi-

tioners applying the accounting

standards in this area correctly

because where the standards have

been correctly applied, tax relief

is granted on the bonus plus the

employers national insurance

contributions.

FRS 21 ‘Events After the Balance

Sheet Date’ was issued on 20

May 2004 and replaced SSAP

17 ‘Accounting for Post Balance

Sheet Events’. FRS 21 removes the

requirement to recognise dividends

proposed after the balance sheet

date. The international equivalent,

IAS 10 ‘Events After the Reporting

Date’ is identical in nature.

Figure 3Lucas Limited is the parent of

a group. Gabriella Limited is a

wholly owned subsidiary of Lucas

Limited and the board of Gabriella

Ltd announced on 4 January 2010

that it will pay dividends in relation

to the year ended 31 December

2009 on 11 January 2010.

In applying FRS 21 (IAS 10), Lucas

Limited should not recognise a

for the year ended 31 December

2009 because the dividend has

been declared subsequent to the

year end. In addition, Gabriella

Limited did not have an obligation

(legal or constructive) to pay the

dividend (FRS 12 / IAS 37).

It is often the case that the board

of directors of a company will pay

-

tors/staff. Clearly in many cases the

ascertained until some time after

the year end and in many cases,

companies will have a prescribed

formula for calculating the bo-

nuses.

Figure 4Over the years, Company B has

directors based on a percentage

statements for the year ended

31 December 2009 have been

completed on 28 February 2010

and the directors have made a

provision for bonuses.

Company B has a construc-

tive obligation to pay the

bonuses in accordance

with FRS 12 (IAS 37)

because past practice

has always been to pay

and therefore the

directors ‘expect’

It is this ‘expectation’ and past

practice which allows Company B

to provide for the bonus.

related bonuses at the year end in

previous years, thus not giving rise

to an expectation on the part of

the directors, then they should not

provide for the bonuses because

they would not have a constructive

obligation.

is the audit and technical partner at Leavitt Walmsley Associates Ltd and the author of:

‘The Interpretation and Application of International Standards on Auditing’.

Steve Collings