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"o s$##arise- a %o#any #$st rovide &or a liability where the three de&ining%riteria o& a rovision are #et, b$t %onversely a %o#any %annot rovide &or aliability where they are not #et! "he latter art o& the above #ay see#obvio$s, b$t it is an area where there has been so#e ast ab$se o&rovisioning as is re&erred to in (b)!

(b)"he #ain need &or an a%%o$nting standard in this area is to %lari&y andreg$late when rovisions sho$ld and sho$ld not be #ade! /any %ontroversialareas in%l$ding the ossible ab$se o& rovisioning are based on %ontraveningase%ts o& the above de&initions! 0ne o& the #ost %ontroversial ea#les o&rovisioning is in relation to &$t$re restr$%t$ring or reorganisation %osts (o&tenas art o& an a%$isition)! "his is so#eti#es etended to roviding &or &$t$reoerating losses! "he attra%tion o& roviding &or this tye o& eenseloss isthat on%e the rovision has been #ade, the &$t$re %osts are then %harged tothe rovision s$%h that they byass the ro&it and loss a%%o$nt (o& the eriod

when they o%%$r)! S$%h rovisions %an be glossed over by #anage#ent asan e%etional ite#, whi%h analysts are ee%ted to disregard whenassessing the %o#anys &$t$re rose%ts! *& this tye o& rovision were to bein%ororated as a liability as art o& a s$bsidiarys net assets at the date o&a%$isition, the rovision itsel& wo$ld not be %harged to the ro&it and lossa%%o$nt!

FRS 12 now prevents this practice as future costs and operating losses(unless they are for an onerous contract) do not constitute past events.

Another i#ortant %hange initiated by FRS 12 is the way in whi%henviron#ental rovisions #$st be treated! Pra%ti%e in this area has di&&ered%onsiderably! So#e %o#anies did not rovide &or s$%h %osts and those thatdid o&ten a%%r$ed &or the# on an ann$al basis! *& say a %o#any ee%tedenviron#ental site restoration %ost o& 13 #illion in 13 years ti#e, it #ightarg$e that this is not a liability $ntil the restoration is needed or it #ay a%%r$e1 #illion er ann$# &or 13 years (ignoring dis%o$nting)! So#ewhat%ontroversially this ra%ti%e is no longer ossible! FRS 12 re$ires that i& theenviron#ental %osts are a liability (legal or %onstr$%tive), then the whole o& the%osts #$st be rovided &or i##ediately! "hat has led to large liabilitiesaearing in so#e %o#anies balan%e sheets!

A third ea#le o& bad ra%ti%e is the $se o& big bath rovisions and overrovisioning! *n its si#lest &or# this o%%$rs where a %o#any #a'es a largerovision, o&ten &or non.se%i&i% &$t$re eenses, or as art o& an overallrestr$%t$ring a%'age! *& the rovision is deliberately overrovided, then itslater release will i#rove &$t$re ro&its! Alternatively the %o#any %o$ld%harge to the rovision a di&&erent %ost than the one it was originally %reated&or! FRS 12 addresses this ra%ti%e in two ways- by not allowing rovisions tobe %reated i& they do not #eet the de&inition o& an obligation and se%i&i%allyreventing a rovision #ade &or one eense to be $sed &or a di&&erenteense! 4nder FRS 12 the original rovision wo$ld have to be reversed and

a new one wo$ld be %reated with aroriate dis%los$res! 5hilst thistreat#ent does not a&&e%t overall ro&its, it does enhan%e transaren%y!

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Note: other exaples would !e accepta!le.

(%)6$arantees or warranties aear to have the attrib$tes o& %ontingentliabilities! *& the goods are sold &a$lty or develo a &a$lt within the g$arantee

eriod there will be a liability, i& not there will be no liability! "he AS+ view thisroble# as two searate sit$ations! 5here there is a single ite# warranty, it is%onsidered in isolation and o&ten leads to a dis%losable %ontingent liability$nless the %han%es o& a %lai# are tho$ght to be negligible! 5here there are an$#ber o& si#ilar ite#s, they sho$ld be %onsidered as a whole! "his #ay#ean that whilst the %han%es o& a %lai# arising on an individ$al ite# #ay bes#all, when ta'en as a whole, it sho$ld be ossible to esti#ate the n$#ber o&%lai#s &ro# ast eerien%e! 5here this is the %ase, the esti#ated liability isnot %onsidered %ontingent and it #$st be rovided &or!

(i) +odylines 27.day re&$nd oli%y is a %onstr$%tive obligation! "he

%o#any robably has noti%es in its shos in&or#ing %$sto#ers o& thisoli%y! "his wo$ld %reate an ee%tation that the %o#any will hono$rits oli%y! "he liability that this %reates is rather tri%'y! "he %o#any willee%t to give %$sto#ers re&$nds o&-

189,333 (1,893,333 13:)!

"his is not the liability! 83: o& these will be resold at the nor#al sellingri%e, so the e&&e%t o& the re&$nd oli%y &or these goods is that the ro&iton their sale #$st be de&erred! "he easiest way to a%%o$nt &or this is to#a'e a rovision &or the $nrealised ro&it! "his has to be %al%$lated &ortwo di&&erent ro&it #argins-

"oods anufactured !y #eader (at a ar$ up of %&' on cost):2;,933 (189,333 83: 23:) ;31;3 < 8,333"oods fro other anufacturers (at a ar$ up of 2' on cost:)=7,333 (189,333 83: 73:) 29129 < 1=,>33

"he sale o& the re#aining ?3: at hal& the nor#al selling ri%e will%reate a loss! Again this #$st be %al%$lated &or both gro$s o& sales-

"oods anufactured !y #eader were originally sold &or 13,933(189,333 ?3: 23:)! "hese will be re.sold (at a loss) &or hal& thisa#o$nt i!e! 9,293! "h$s a rovision o& 9,293 is re$ired!"oods anufactured !y other anufacturers were originally sold 2,333 (189,333 ?3: 73:)! "hese will be re.sold (at a loss) &orhal& this a#o$nt i!e! 21,333! "h$s a rovision o& 21,333 is re$ired!

"he total rovision in rese%t o& the 27 day ret$rn &a%ility will be92,793 (8,333 @ 1=,>33 @ 9,293 @ 21,333)!

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(ii) 6oods li'ely to be ret$rned be%a$se they are &a$lty re$ire a di&&erenttreat#ent! "hese are e&&e%tively sales ret$rns!

or#ally the #an$&a%t$rer will rei#b$rse the %ost o& the &a$lty goods!"he e&&e%t o& this is that +odyline will not have #ade the ro&it originally

re%orded on their sale! "his alies to all goods other than thoses$lied by Beader! "h$s these sales ret$rns wo$ld be 127,333(1>3,333 73:) and the %redit d$e &ro# the #an$&a%t$rer wo$ld be132,;33 (127,333 133129 re#oval o& ro&it #argin)!

"he overall e&&e%t is that +odyline wo$ld have to re#ove ro&its o&29,>33 &ro# its &inan%ial state#ents!

For those goods s$lied by Beader, +odyline #$st s$&&er the wholeloss as this is re&le%ted in the negotiated dis%o$nt! "h$s the rovisionre$ired &or these goods is ?2,333 (1>3,333 23:), giving a total

rovision o& 98,>33 (29,>33 @ ?2,333)!

(d)"he ire%tors roosed treat#ent is in%orre%t! "he rela%e#ent o& the engineis an ea#le o& what has been des%ribed as %y%li% reairs or rela%e#ent!5hilst it #ay see# logi%al and r$dent to a%%r$e &or the %ost o& a rela%e#entengine as the old one is being worn o$t, s$%h ra%ti%e leads to do$ble%o$nting! 4nder the ire%tors roosals the %ost o& the engine is beingdere%iated as art o& the %ost o& the asset, albeit over an in%orre%t ti#eeriod!

"he sol$tion to this roble# lies in FRS 19 A%%o$nting &or Fied Assets! "helant %onstit$tes a %o#le asset i!e! one that #ay be tho$ght o& as havingsearate %o#onents within a single asset! "h$s the lant 1>D9 #illion (total%ost o& 2; #illion less 8D9 ass$#ed %ost o& the engine) sho$ld bedere%iated at 1D>9 #illion er ann$# over a 13.year li&e and the enginesho$ld be dere%iated at 1,933 er ho$r o& $se (ass$#ing #a%hine ho$rdere%iation is the #ost aroriate #ethod)! *& a &$rther rovision o& 1,933er #a%hine ho$r is #ade, there wo$ld be a do$ble %harge against ro&it &orthe %ost o& the engine!

FRS 12 also re&ers to this tye o& rovision and says that the &$t$rerela%e#ent o& the engine is not a liability! "he reasoning is that therela%e#ent %o$ld be avoided i&, &or ea#le, the %o#any %hose to sell theasset be&ore rela%e#ent was d$e! *& an ite# does not #eet the de&inition o& aliability it %annot be rovided &or!