BIM46550 - Specific deductions: provisions:
FRS12: examples of the effect of the standard
You may obtain a better appreciation of the effect of the
standard by considering how its application would have impacted on
the following cases which all predated the adoption of FRS12:
- Herbert Smith v Honour [1999] 72TC130 - a
provision was made equal to the undiscounted value of future
rentals payable in respect of premises no longer used in the
partnership. Under FRS12 such a provision in respect of future
obligations under a lease would still be recognised since the four
conditions for recognition are met. However, discounting to reflect
the present value of the future rentals would probably be necessary
since FRS12 requires this where the effect of the time value of
money is material.
- Jenners (Edinburgh) Ltd v CIR (SpC166/98)
- the directors completed a feasibility study during the accounting
year to 31 January 1995 on the possibility of refurbishing the
company's store. The company did not sign a contract with builders
for the refurbishment until April 1995, but reflected a provision
in its accounts to 31 January 1995 for the full expected cost of
the work. This would not be permitted under FRS12 since the
commitment, 'the present obligation', had not arisen. FRS12 would
also not have permitted a provision in Jenners' accounts to 31
January 1996 for the expenditure still to be incurred in the
following year. Although the contract with the builder was made in
April 1995, a contract of this type is an executory contract, so a
liability under FRS12 does not arise until the work has been
carried out. In addition, a business that uses an asset under an
operating lease can make a provision under FRS12 for repairs that
it is required to make under the terms of the lease, since a
commitment for repairs builds up under an existing legal
obligation. We now accept that ICTA88/S74 (d) does not lay down a
timing rule preventing the deduction of such provisions.
- Johnston v Britannia Airways Ltd [1994]
67TC99 (1994 STC763) - the company operated an airline fleet, some
of which it owned and some of which it leased. By law aircraft in
the fleet would not be able to operate unless certified to do so. A
condition for certification was that their engines were overhauled
after 17,000 hours of operation. The company accrued the estimated
cost of repairs over the 17,000 flying hours. It was held by the
Commissioners and High Court that this was acceptable for tax.
Under FRS12, this accounting treatment would not be acceptable for
aircraft owned by the company since no 'present obligation' would
exist until the repairs were made. The signing of the contract for
repairs to be carried out would be an executory contract and would
not create a present obligation until the repairs were actually
carried out. It would not be allowable under FRS12 to recognise a
provision simply because a contract for the repairs existed. Where
the aircraft was operated under an operating lease requiring
repairs under its terms, then a provision would be established for
the repairs as the obligation to carry them out accrued.
