BIM46515 - Specific deductions: provisions: accounting standards and GAAP: FRS12

Until September 1998 there was little explicit GAAP on provisions. The 'prudence' concept in SSAP2 required provision to be made for all known liabilities whether the amount of these was known with certainty or was a best estimate in the light of the information available. In addition SSAP18 ‘contingencies’ required provision to be made for ‘contingent losses’ where it was probable that a future event would confirm a loss which could be estimated with reasonable accuracy. In practice GAAP gave wide latitude to directors in the making of provisions and the 'prudence' concept was used to justify provisions on a very cautious, or even pessimistic, basis.

In September 1998 the Accounting Standards Board issued FRS12 ‘Provisions, contingent liabilities and contingent assets’ which prescribes the circumstances in which provisions can be made. This supersedes SSAP18 ‘contingencies’. FRS12 has effect for accounting periods ending on or after 23 March 1999. Earlier adoption was ‘encouraged but not required’; this means that businesses which chose not to adopt FRS12 before the effective date cannot be forced to do so, for tax or any other purposes.

The basis of FRS12 is that provisions must satisfy the definition of liabilities: 'obligations of an entity to transfer economic benefits as a result of past transactions or events'. Mere anticipation of future expenditure, however probable and no matter how detailed the estimates, is not enough, in the absence of an obligation at the balance sheet date. Provisions are defined by FRS12 as 'liabilities of uncertain timing or amount'.

FRS12 lays down a complete code prescribing when provisions must be made, and when they must not, and also lays down rules for the quantification of provisions.

FRS12 does not apply to:

• Trade creditors, which are defined as liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier.
• Accruals, which are defined as liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts related to accrued holiday pay.
• Adjustments to the carrying value of assets such as stock provisions, bad debt provisions and provisions for depreciation.
• Insurance company provisions arising from contracts with policyholders.
• Provisions which are specifically addressed by other accounting standards, such as: