BIM46520 - Specific deductions: provisions: accounting standards and GAAP: FRS12: when a provision can be made

Under FRS12 provisions should be made in the financial statements when and only when at the balance sheet date:

• The business is under a present legal or constructive obligation - a ‘constructive obligation’ is where as a result of ‘an established pattern of past practice, published policies or a sufficiently specific current statement’ the business has created a ‘valid expectation’ that it will meet certain responsibilities. An example is where it is well known that a shop habitually gives refunds on purchases even without legal liability to do so. Another is a business with a widely published environmental policy, and a record of honouring it, which finds contamination on one of its sites. There may be a ‘constructive obligation’ to clean it up.
• The obligation is as a result of a past event, and
• • it is probable that there will be a ‘ transfer of economic benefits’ arising from the obligation. For example if a company is sued for alleged damages a provision can be made only if the company, on legal advice, considers it more likely than not that it will have to pay something. Where liability is possible but not probable a provision is not allowed but it may be disclosed as a ‘contingent liability’, and
  • a reliable estimate of the amount of the provision can be made.

The Accounting Standards Board considers that it will be extremely rare for it to be impossible to make a reliable estimate if the first three conditions are satisfied.