Provisions

Provisions Bad Debts Depreciation Accruals UK Companies Act Financial Reporting Standard IAS 37
An amount set aside out of profits in the accounts of an organization for a known liability, even though the specific amount might not be known, or for the diminution in value of an asset.
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What is a Provision?

A provision is an amount set aside from a company’s profits to cover known liabilities or reduce the value of an asset. These liabilities may not have a determined value or precise payment date at the close of the accounting period. Provisions differ from reserves in that they recognize anticipated liabilities and losses, whereas reserves set aside profits for discretionary use.

Examples

  1. Provisions for Bad Debts: These are funds set aside to cover debts that the company estimates it will not be able to collect from its customers.
  2. Provisions for Depreciation: This involves allocating funds to account for the diminishing value of the company’s assets over time.
  3. Provisions for Accruals: These are made for expenses that are known to be owed in the current accounting period but have not yet been paid.

Frequently Asked Questions

  • Q1: What distinguishes a provision from a reserve?

    • A1: Provisions are meant to cover specific liabilities or reduce asset values, while reserves are portions of profits allocated for future use at management’s discretion.

  • Q2: How must provisions be documented under the UK Companies Act?

    • A2: Every material provision in the accounts of a limited company must be explained with notes, ensuring transparency and compliance with the act.

  • Q3: Why is the definition of provision narrowly defined under current accounting rules?

    • A3: To prevent abuses and ensure accurate financial reporting, current rules define a provision as a definite liability arising from a past event, though its timing or amount may be uncertain.

  • Q4: Where can specific guidance on provisions be found for the UK and Ireland?

    • A4: Detailed guidance is available in Section 21 of the Financial Reporting Standard applicable in the UK and Republic of Ireland.

  • Q5: What international standard addresses provisions?

    • A5: IAS 37, Provisions, Contingent Liabilities, and Contingent Assets, is the relevant International Accounting Standard.
  • Bad Debts: Debts that are not expected to be recovered, leading to a loss for the company.
  • Depreciation: The reduction in the value of an asset over time, often due to wear and tear.
  • Accruals: Accounting adjustments for expenses that have been incurred but not yet paid or for revenue that has been earned but not yet received.
  • Reserves: Portions of profits saved for future use, often for unforeseen liabilities or investments.
  • IAS 37: An International Accounting Standard that deals with the accounting for provisions, contingent liabilities, and contingent assets.

Online References

Suggested Books for Further Studies

  • “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield: A comprehensive guide to accounting principles, including detailed discussions on provisions and other key concepts.
  • “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott: This book delves into financial reporting standards and includes practical examples of provisions.
  • “Accounting: The Basis for Business Decisions” by Robert F. Meigs and Walter B. Meigs: Provides foundational knowledge, with sections dedicated to understanding provisions in accounting.

Accounting Basics: “Provisions” Fundamentals Quiz

### What is a provision primarily used for in accounting? - [ ] To save profits for future investments. - [x] To cover known liabilities or reduce the value of an asset. - [ ] To pay dividends to shareholders. - [ ] To increase company reserves. > **Explanation:** A provision is set aside to cover known liabilities or to account for the reduction in the value of an asset. It's a preparatory measure to handle future obligations. ### Why are provisions different from reserves? - [x] Provisions are for specific liabilities; reserves are for future discretionary use. - [ ] Provisions increase profits; reserves decrease profits. - [ ] Provisions are created by shareholders; reserves are created by creditors. - [ ] There is no significant difference between provisions and reserves. > **Explanation:** Provisions cover anticipated liabilities or losses, whereas reserves are set aside from profits for discretionary future use. ### Under the UK Companies Act, what must be provided for each material provision? - [ ] An executive summary. - [x] Detailed explanatory notes. - [ ] A legal contract. - [ ] A shareholder vote. > **Explanation:** The UK Companies Act mandates detailed notes explaining each material provision to ensure transparency in financial reports. ### What kind of liability does a provision account for, according to current accounting rules? - [ ] Potential future responsibilities. - [x] Definite liabilities arising from past events of uncertain timing or amount. - [ ] Employee benefits. - [ ] Shareholder equity issues. > **Explanation:** Provisions are meant for definite liabilities that arise from past events, even if their timing or amount is unclear. ### Which section of the Financial Reporting Standard applies to provisions in the UK and Ireland? - [ ] Section 10 - [ ] Section 17 - [x] Section 21 - [ ] Section 25 > **Explanation:** Section 21 of the Financial Reporting Standard provides detailed guidance on the accounting for provisions. ### Which international accounting standard pertains to provisions? - [ ] IAS 1 - [ ] IAS 16 - [ ] IAS 24 - [x] IAS 37 > **Explanation:** IAS 37 is the International Accounting Standard that covers provisions, contingent liabilities, and contingent assets. ### What is a common example of a provision in accounting? - [ ] Provisions for income increases - [x] Provisions for bad debts - [ ] Provisions for revenue fluctuations - [ ] Provisions for shareholder distributions > **Explanation:** Provisions for bad debts are commonly used to set aside amounts for debts that are not expected to be collected. ### For what reason do companies create provisions for depreciation? - [ ] To increase the asset value on the balance sheet. - [x] To account for the diminishing value of assets over time. - [ ] To save funds for employee bonuses. - [ ] To reduce shareholder equity. > **Explanation:** Provisions for depreciation allocate funds to account for the reduction in the value of assets as they wear out or become obsolete. ### How should a company treat an expense that is known but not yet paid by the period-end? - [x] Create a provision for the expense. - [ ] Ignore it and recognize it in the next period. - [ ] Adjust shareholder equity. - [ ] Treat it as revenue. > **Explanation:** If an expense is known but not yet paid, a company should create a provision to recognize this liability in the current accounting period. ### What is included in a provision for bad debts? - [ ] Amounts expected to improve revenue. - [ ] In-curd interest expenses. - [ } Expected utility cost savings. - [x] Amount set aside for uncollectible debts. > **Explanation:** Provision for bad debts involves setting aside an estimated amount for debts that a company does not expect to collect from customers.

Thank you for exploring the concept of provisions in accounting and participating in our quiz. Continue enhancing your understanding of financial concepts to excel in your accounting endeavors!

Tuesday, August 6, 2024
Proviso
Provision for Depreciation
Adjusting Entries January 1, 1
Deferred Taxation January 1, 1

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