Financial statements must include all the information necessary for an understanding of the company’s financial position. Provisions, contingent liabilities and contingent assets are “uncertainties” that must be accounted for consistently if are to achieve this understanding.
A provision is a liability of uncertain timing or amount.
A liability is an obligation of an entity to transfer economic benefits as a result of past transactions or events.
The financial reporting standard distinguishes provisions from other liabilities such as trade creditors and accruals. This is on the basis that for a provision there is uncertainty about the timing or amount of the future expenditure. Whilst uncertainty is clearly present in the case of certain accruals the uncertainty is generally must less than for provisions.
Financial reporting standard states that a provision should be recognized as a liability in the financial statements when,
- An entity has a present obligation as a result of a past event
- It is probable that a transfer of economic benefits will be required to settle the obligation
- A reliable estimate can be made of the obligation
Measure of Provisions
The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The estimates will be determined by the judgment of the entity’s management supplemented by the experience of similar transactions.
Allowance is made for uncertainty. Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditure required to settle the obligation. An appropriate discount rate should be used.