Provisions, contingent liabilities and contingent assets - FRS 12
FRS 12 - in force for year ends after 22 March 1999
For preparers of accounts the essence of FRS 12 is that many provisions presently permitted will not be allowed, and many new provisions are required. Provision can be made only for obligations (liabilities) that exist at the balance sheet date. Ordinarily, future operating costs may not now be provided for, nor mere intentions to incur expenditure.
The target for these changes is the so called "big bath" restructuring provision, whereby a large and allegedly expansive accrual is made to bring (the expenses relating to) all the bad news into one year. Subsequent expenditure, perhaps lasting several years, relating to matters such as such as redundancy and reorganisation, is then offset against the provision, so that earnings in the actual years of the expenditure are unaffected.
Also hit are provisions for future maintenance costs. Before FRS 11 it was considered prudent to accrue for foreseeable future re-fit costs, for example of aircraft engines or furnace linings. Now we must accept that there is no liability to provide for until the work is started; prior to that time the business has the option to take the asset out of service, for example, and hence has no obligation to record in its accounts. Moreover, the refurbishment expenditure, when it does occur, will often now be capitalised as a fixed asset enhancement and then depreciated, rather than be written off as an expense.
Oppositely, FRS 12 will bring any legal liability for environmental clean up costs onto a company's balance sheet from the moment the obligation is incurred, that is from the day the soil or sea bed is first disturbed. The impact of provisions for expenditure long into the future is reduced, however, by the requirement to discount such liabilities to present values.
As regards contingencies, FRS 12 makes no substantial changes to the ideas of the superseded SSAP 18. However, the new standard requires that any liability reckoned to have a better than 50% chance of crystalising should be provided for, whereas the old standard required provision for "probable" liabilities, and left a lot of scope for argument over the meaning of probable.
This website is intended for general guidance only. No responsibility for loss occasioned to any person acting as a result of any material in this publication can be accepted.
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